A Tartan (Flat) Tax?

Type: Think Pieces Written by Dr Eamonn Butler | Tuesday 7 December 2004

Is it time to move towards Flat Tax? According to Eamonn Butler it is a good time for Scotland to go for it. Though they would need permission from Gordon Brown, it would be a great step for Scotland. He looks at how various countries have proven that having a Flat tax works.

Like all of us, Gordon Brown is struggling to make ends meet. Public spending has skyrocketed, but tax receipts - though up 7% - are well below his optimistic ambitions. He needs to spend less (fat chance!), or raise more money.

But New Labour knows tax is unpopular, and has pegged income-tax rates. The media have rumbled his stealth-tax scams. So what can he do?

A radical suggestion comes from David Clarkson, head of tax at PriceWaterhouseCoopers, in Glasgow. Scrap all the vast complexities, he says, and have a single, low rate of tax for everyone - a so-called 'Flat Tax'. Something so easy, so obvious, so pointless to fiddle or avoid, that the Treasury would actually pull in more revenue than today.

When accountants start saying the tax system is too complicated, you know you have problems. Tolley's Yellow Tax Guide - the accountants' bible - now fills 7,344 pages across four volumes. Last year alone saw 400 pages of new tax law. Judges struggle to rule on more numerous and more complicated tax disputes.

But nine countries - and Clarkson suggested that Scotland might become the tenth – have already cleared the complexity from their systems and brought in a Flat Tax. It’s no longer just theory: you can see it working, and producing benefits.

Those nine, including four in the EU, tore up their tax laws and brought in a Flat Tax. And when you scrap all those reliefs and allowances, all the different rates, all the pension credits and tax credits that nobody understands - you find that you need a much lower rate of tax. Indeed, you could double the personal allowance – so that nobody earning under £10,000 a year pays any tax at all - and have a low rate of just 20% for everyone, without the Treasury losing a penny.

Now that might sound like a tax plan for the rich. The multi-millionaire Steve Forbes was keen on it when he ran for US President back in 1996. But remarkably, the Flat Tax countries have found that the rich actually pay more. Why? Because when tax is high, it is worth top-rate taxpayers (that's a lot of us these days) hiring expensive lawyers and accountants to set avoid it: in Britain, every £100 sheltered is £40 in the bank. But if the tax rate is just 20%, that incentive is halved. The same with fiddling: at 20%, the saving is not worth the risk. Nor is there much point in big earners moving abroad - meaning their wealth and capital remain at home, helping to generate economic growth.

So the Flat Taxers see their revenues rising - and the rich paying a bigger share. Rates are lower, but more people pay up. It is more worthwhile to start new businesses. Foreign investors are attracted. Business grows and people prosper.

Hong Kong has had a Flat Tax for fifty years. The Channel Islands scrapped the British tax code and moved to a Flat Tax in the 1960s. The new EU members Latvia, Lithuania and Estonia went for it in the early 1990s, as did Russia, a G8 country. (Estonia is cutting its Flat Tax from 26% to 20%, because it is losing trade and investment to neighbouring Russia, with a rate of just 19%.)

Certainly, such radicalism is not easy. Ivan Miklos, the finance minister of Slovakia – another new EU member, only two-thirds as wealthy as Scotland, but with the same population – told me that his 19% Flat Tax plan was the only decision he ever lost sleep about. "But keeping our old system was even more unpopular," he said. "So we just did it." And now, his tax revenues are rising.

These are powerful lessons. Now the Bush Administration is contemplating it, even China is debating it. The Flat Tax is definitely in fashion.

Could Scotland go for it? Gordon Brown would have to agree, so it would take an enthusiastic campaign to succeed. But there is nothing to lose. The UK tax system has run into the sands of complexity.

The Parliament’s 3% tax-raising power, its high spending, the Council Tax assault on second home - all these frighten off overseas investors and drive high-earning Scots - like many of those listed in this paper last week - abroad. Meanwhile, at the other end of the income spectrum, a third of full-time workers in Scotland are below UK average wages, and presently face huge marginal rates of tax. Under a Flat Tax, with a £10,000 starting threshold, the poorest workers would pay nothing at all. And that would be a powerful incentive for people to get off benefits and into work - and stay there.

It's time for Scotland to pioneer something radically different. Perhaps Mr Clarkson is on to something.

Dr Eamonn Butler is Director of the Adam Smith Institute. This article was originally published in The Scotsman newspaper.