Tax bands should be scrapped to allow a more progressive system that would give money back to most taxpayers while raising the same amount of revenue, according to the Institute for Public Policy Research.

In its latest paper entitled Tapering Over the Tax¸ the body said as things stand, “the variable treatment of different sources of income reduces the current system’s progressivity, creates perverse economic incentives and helps to create political opposition to tax rises”.

This policy paper proposed a major reform of the current system, with two elements. First, all rates and allowances within income tax and employee national insurance contributions would be combined into a single tax ‘schedule’, with all sources of income taxed at the same rate, and on the same basis. Second, the existing system of marginal tax bands would be replaced by a ‘formula-based’ system such that every taxpayer’s marginal rate would depend on their own precise level of income.

“Such a system would be more efficient and progressive, and in addition could be used to raise revenues in a way that is fairer and more politically acceptable than the current system,” the Institute said.

“The UK’s current system of taxing individual incomes combines two different tax schedules, for income tax and employees’ national insurance contributions (NICs), in a complicated arrangement of different tax rates, bands, thresholds, allowances and reliefs. Assessed against three simple principles of tax design – efficiency, progressivity and system coherence – the UK’s current system performs poorly. In terms of efficiency, the rate of taxation on incomes often varies arbitrarily. For example, the effective rate of tax on annual earnings from employment above the tax-free allowance is 32 per cent, compared to 7.5 per cent for income paid in dividends from company profits.

“The marginal rate of income tax also jumps from 40 per cent to 60 per cent and back to 40 per cent as the personal allowance is withdrawn for incomes over £100,000. For income tax payers on the lowest earnings, effective marginal tax rates can be as high as 75 per cent as means tested benefits are withdrawn as a result of higher pay. This variable treatment of different sources of incomes, combined with sharp ‘cliffs’ in the marginal rate between tax bands, creates perverse economic incentives, makes tax avoidance more likely and is far from transparent. Overall, the UK’s tax system is not progressive. On average, the poorest 20 per cent of households pay 35 per cent of their gross income in tax, far more than the average for all other households. The system of taxing an individual’s income should be the key mechanism to make the tax system more progressive and fair as a whole.”

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