Taxing income from wealth the same as income from work could raise £90 billion over five years, report finds

Ending special treatment for capital gains should be a first step in a radical overhaul of the UK’s unfair and outdated tax system, says IPPR

Wealthy people who make huge profits by buying and selling assets should pay the same rates of tax as those who work hard for a living, according to a report from the IPPR think tank.

If everyone who makes ‘capital gains’ paid the same tax rate as earnings from work, it could generate at least £90 billion in extra revenue over five years, the report finds.

Cash for schools, education and the police announced in the Chancellor's Spending Review last week (Sept 4) is only a fraction of what the UK’s public services will need to end austerity and meet future demand. Even the £13.8 billion promised is unlikely to be possible without breaching the government’s current fiscal rule, as it would be funded from fiscal “headroom” likely to have dwindled since the Spring forecast.

The new IPPR report makes clear that meeting this long-term spending challenge will only be possible by overhauling the tax system and the way income from wealth is treated in the UK.

The report explains that the current tax system is also deeply unfair, as two people who earn the same amount can end up paying vastly different amounts of tax depending on the source of their earnings. Someone on a £50,000 a year salary would pay 42 per cent of a £20,000 pay rise in tax, but just 8 per cent of their additional income if they received £20,000 profit from selling non-residential assets.

The think tank says that this disparity makes inequality worse, as the wealthiest people are more likely to get income from wealth and hence can end up paying less tax than they would if their income was from work. Not only this, but the wealthiest are also more able to avoid their tax obligations by shifting their income source from wages so that they are paid in the form of capital gains and dividends, which are taxed more lightly.

This dynamic means the rich can continually get richer, whilst everyone else struggles to catch up. According to the report, people’s life chances will be increasingly determined by the wealth of the family they are born into.

IPPR argues that raising taxes on income from wealth to the same level as those on income from work is a necessary step to break this cycle and restore a sense of justice to our economic system.

The report includes quantitative modelling of policies first proposed by the landmark IPPR Commission on Economic Justice, which launched its final report one year ago. The Commission’s final report recognised that greater redistribution through the tax system is essential for economic justice.

The capital gains tax proposal is based on the simple principle that income, regardless of its source, should be taxed equally. To achieve this, IPPR recommends:

• Abolishing separate tax rates on capital gains by incorporating them into the income tax schedule.

• Removing most exemptions, allowances and reliefs that currently exist – bringing capital gains in line with taxation of earnings from work.

These changes could raise up to £120bn of additional revenue over five years, adjusted to £90bn following potential behavioural changes, which are modelled in the report.

The report also makes the case for a radical overhaul of the current system for taxing other income. IPPR proposes merging income tax and employee NICs - replacing the current system of sharply changing marginal tax rates and variable personal allowances with a single, formula-based tax rate applied on all income regardless of source, that rises gradually between lower and upper thresholds (2 per cent for the lowest earners to 50 per cent for the very highest earners). IPPR argues this would make the tax system simpler and fairer.

It would mean that as people earn more, they would pay slightly more of their extra income in tax, and people would pay the same tax on their income no matter how it was earned. Beyond greater transparency, this would also avoid the ‘cliff edge’ transitions between marginal rates that create incentives and opportunities for tax avoidance.

These reforms would make the tax system more progressive, with the tax burden being redistributed from lower to higher earners. A revenue-neutral transition would mean average tax bills falling for those earning under £44,800 - over three quarters of all income taxpayers. Someone on the average UK salary of £26,000 would see their income tax bill fall by 4 percentage points– the equivalent to an extra £1000 a year.

For a government prepared to take seriously the need to raise significant additional revenue, this model presents considerable advantages. With just a minor increase in the tax rate, the formula-based model can raise significant revenue whilst a majority remain ‘winners’ through the reform.

Taken together these proposals amount to a transformation of the taxation of income which would move the UK towards a more economically just system; both raising greater revenue for vital public spending and reducing the tax burden on the poorest.

Tom Kibasi, Director of the IPPR, said:

“This is a matter of basic fairness. It is fundamentally wrong that people who get their income from betting on the stock and shares or playing the property market pay less tax than those who go out to work each day to provide for their families. The current tax system works for the rich, designed to help them avoid paying their fair share. As the landmark IPPR Commission on Economic Justice showed, there is an alternative where prosperity and justice go hand-in-hand. Taxing all income in the same way would be a crucial step forward.”

Carys Roberts, IPPR Chief Economist and Head of the Centre for Economic Justice, said:

“The spending review may have set the budgets for the coming 12 months, but the real question is how to ensure our tax system raises the revenue we need, while creating a prosperous and just economy.

“Our proposals to meet this challenge are based on a simple idea: that all income should be taxed the same, whether from wealth or from work. It’s not justifiable that the wealthy, who are more likely to receive income in capital gains, should contribute less tax than ordinary people who work for their income. Our proposal is a radical break from current policy, but a sensible response to a broken economy and growing gap between those with assets and those without.”

Henry Parkes, IPPR Senior Economist, said:

“Our system of income tax harks back to a pre-digital age. The government has to modernise and simplify the system. Our analysis shows that this could be done in a progressive way which raises public money whilst protecting the lowest paid and avoiding excessively high rates of marginal tax on the highest earners.”

ENDS

NOTES TO EDITORS

1. The IPPR paper, Just Tax: Reforming the taxation of wealth and work by Henry Parkes and Shreya Nanda is available for download at https://www.ippr.org/research/publications/just-tax
2. Figures provided include the removal of entrepreneur’s relief. Removal of death relief is not included in this proposal but is modelled as a further policy option in the full report. We do not propose scrapping the exemption on primary residences.
3. A formula-based schedule produces a more even increase in marginal and average tax rates. This graph compares the current marginal rate with the IPPR formula–based model:

4. The income tax modelling uses the IPPR tax-benefit microsimulation model to estimate the impacts of tax regime changes on government revenue, using data from the Family Resources Survey.

5. The Capital Gains tax modelling uses published HMRC data on disposals to estimate the impact on revenue from having tax rates aligned with the income tax schedule. The amount raised by removal of allowances is based on previous HMRC estimates with relevant adjustments to bring the estimates up to date and we have considered the interaction between these changes. We estimate potential behavioural impacts based on earlier work from HM Treasury, scrutinised by the Office for Budget Responsibility, on raising CGT rates. The paper explains the methodology in detail.

We have not modelled bringing any other sources of income in line with the tax schedule, such as dividend income.

6. The IPPR Commission on Economic Justice published its final report Prosperity and Justice: A Plan for the New Economy a year ago (on September 5^th, 2018). The commission was established in 2016 and convened a diverse group of Commissioners including the Archbishop of Canterbury, the head of the City of London Corporation, and the general secretary of the TUC. Prosperity and Justice contained 73 radical proposals to reshape the UK economy, and argued that hard-wiring the economy for justice would also generate stronger growth.

7. IPPR is the UK’s pre-eminent progressive think tank. With more than 40 staff in offices in London, Manchester, Newcastle and Edinburgh, IPPR is Britain’s only national think tank with a truly national presence.