Tax and benefit systems must do more to make work pay

The current system of redistribution through taxation and welfare is inefficient and could be reformed to give more support to those on low and middle incomes according to a new report for the Resolution Foundation.

The report, written by Paul Johnson, Director of the Institute for Fiscal Studies, and drawing heavily on the Mirrlees Review of tax, identifies key reforms that could allow the tax and welfare system to redistribute more efficiently.  It will feed into the Commission on Living Standards whose final report is published in the autumn.

The report, Fairer by design: efficient tax reform for those on low to middle income argues that if politicians are concerned about both growth and redistribution they must grasp the nettle of tax reform. Simply making the current system more generous to those on low incomes will not be sustainable in the long run. Reforms to the structure of welfare, VAT and council tax are required.

The tax-benefit system must do more to ensure work pays for groups who we know respond to incentives and which will be important to rising living standards:

• For parents, cash benefits could be made more generous for younger children and less generous for school-age children when parents are more likely to want to work
• For second earners, the new Universal Credit system could introduce a separate disregard for second earners, allowing them to keep more of the money they earn
• For older workers, National Insurance Contributions (NICs) could be reduced by either bringing forward the age at which people stop paying NICs to 55 or by or increasing the NICs threshold at this age, whilst potentially delaying the age at which Pension Credit becomes available.

The report also argues that politicians must finally grasp the nettle of Council Tax reform. Currently people in lower value homes pay a higher rate (as a proportion of their home value) than people in more expensive homes. The report notes that we don’t charge VAT at a lower rate on a Ferrari than on a Nissan. So why do we charge council tax at a lower rate on a mansion than on a council flat? A flat rate of Council Tax would be both fairer and more efficient. In the short-term, additional bands at the top could enable a freeze on Council Tax for those lower down.

The report also argues that the current system of extensive zero and reduced rating of VAT – much more extensive than in other countries – is an expensive and inefficient way of effecting redistribution. It can be reformed over time in ways which benefit low and middle income households.

Paul Johnson, author of the report said:

‘Redistribution through the tax and welfare system is always economically costly, but the current system is inefficient and imposes far greater costs than are necessary. In the long run if we want a redistributive system then we need to introduce reforms which allow redistribution at lower cost. If politicians are serious about wanting both growth and redistribution they must face up to the need for reform and tackle elements of the tax system which have for too long been in the too difficult box.’

Gavin Kelly, Chief Executive of the Resolution Foundation said:

‘With money so tight we know that gains in household living standards in the next decade will have to come overwhelmingly from employment rather than big increases in state support. Our tax-benefit system and public services will need to do far more to support work – whether for parents held back by lack of childcare or older workers who see little incentive to stay in work.’

Notes to editors

The report, Fairer by design: efficient tax reform for those on low to middle incomes, is available on the Resolution Foundation website.

The report draws on the findings of the Mirrlees Review of efficient taxation: http://www.ifs.org.uk/mirrleesReview

The Commission on Living Standards is an independent and wide ranging investigation into the pressures facing people on low to middle incomes, established by the Resolution Foundation. The report is a contribution to the Commission and is not its final view. The commission will publish its final report in September 2012. www.livingstandards.org

The Resolution Foundation is an independent think tank focused on improving the lives of households on low to middle incomes www.resolutionfoundation.org