We are faced with a situation in which the number of people over 65 is set to rise from 10.5m in 2011 to 14.3m in 2026 – a 36 per cent increase in the number of people who draw benefits but pay little in tax. Meanwhile the number of people under 35 will remain static, and they currently pay at least 40 per cent of their income in tax.
The UK also has a special problem in the collapse of work incentives for people with lower incomes. The last government gave with one hand, through the minimum wage, and took away with the other, through higher taxes on the low paid and increased access to benefits. The net result was that, even in the good times, 20 per cent of the adult workforce was out of work, with very sad results for quality of life and health. Already the return of the over 65s – over 500,000 returned to the workforce in the last three years – has shown the power of incentives, including exemption from national insurance and more generous tax-free allowances.
The coalition government has met criticism for raising tax allowances, but this makes sense as the first step of a much more long-term shift away from taxes on employment to taxes on consumption. The 50 per cent of income tax payers on lower incomes account for just 15 per cent of revenue. The longer-term aim should be to eliminate income tax payment for all those earning under £20,000.
This, especially if we move away from national insurance as a tax, would create powerful new work incentives. It would reduce the fiscal costs of underemployment by bringing back into the workforce many who would otherwise have had the highest claims on public spending. It would give greater traction to the government’s much-needed reforms on welfare. And it would represent a long-overdue reinstatement of the very sound principle that income tax should not fund the income required for subsistence.
This change could be funded by a shift to consumption taxes, mainly through a widening of VAT coverage to include the same range of goods and services as in other developed countries. Such a widening of the VAT base could raise the £20bn to £25bn required to lift 50 per cent of income tax payers out of income tax. It would raise VAT receipts by about 25 per cent.
Consumption taxes make sense in terms of a fairer distribution of the tax burden between those in and out of the workforce. They would be paid by the more affluent elderly and would, in effect, fund many of the extra benefits, like heating allowances, that come their way. It would mean that the baby boomers would make a fairer contribution.
Consumption taxes fall on imports, including imports of services, while income taxes are a tax on domestically-produced outputs. Consumption taxes also increase incentives to save. The main objection to increased use of VAT is the effect on inflation, but this impact will be reduced if the tax is levied across a wider area rather than through increased taxation of a limited range of goods. Consumption taxes are also more flexible as patterns of consumption show much change over a decade.
The long-term strategic aim must be a rebalancing of the tax system so that older people pay some tax as well as receive benefits, and it is more politically feasible to rebalance this way than through reduction in benefits.
It would also assist younger people to get into the workforce. Long-term growth depends on whether younger people can raise their real incomes. This shift away from income tax – at all levels – would be a rare case of a win-win, perhaps the first since Gladstone abolished stamp duty on paper. It would also be a key step in improving health, as people in work have been shown to be much healthier.
This could be the first step in a positive move towards fairer policies for a younger generation which has been described as Ipod – insecure, pressured, overtaxed and debt-ridden – or jinxed. We must create incentives for younger people to raise their real incomes in the global economy. Rather than the Ipod generation, we can have the Aces generation – adaptive to new opportunities, capable, enterprising, and secure in their grip on lifetime savings. A redesign of the tax system is a vital step towards freeing up our most scarce resource – the drive and ability of young people.
Nick Bosanquet is professor of health policy at Imperial College and chair of Volterra Health.