A new way to cut taxes

Rory Sutherland, in his Spectator column of June 8th, says something novel about cutting taxes. Instead of discussing how much taxes might be cut, he considers how they might be cut. He says, as an alternative to simply cutting the rates:

“More interesting would be to hold the tax rate constant, but to refund tax cuts annually in a lump sum. It would then be valued year after year, rather than becoming invisible.”

This brings psychology into the picture. The theory is that if government cuts tax rates, it earns gratitude for a couple of years, then the new rate beds in and people get used to paying less per month in PAYE. On the other hand, an annual rebate keeps oncoming and keeps on earning gratitude.

Suppose, for example, that government decided to cut the basic rate from 20% to 18%. Obviously this would have to be funded by spending cuts, efficiency savings, tax rises elsewhere, or through economic growth. A cut of the top rate from 45% to 40% would probably not have to be funded, in that the lower rate could well yield more revenue by making avoidance less attractive and by stimulating investment and growth.

A cut in basic rate from 20% to 18% could be done by a straight rate cut, or it could be implemented by having people continue to pay at 20%, and giving them an annual rebate of the difference between 20% and 18%. In crude terms this combines a tax cut with forced savings. There is evidence that people would like to save more, but find it difficult. This would give them a helpful nudge.

I have lived in the US and paid taxes there. Many people choose to overpay somewhat, preferring to receive a refund every April rather than a bill. Advertisers know those cheques are entering postboxes at that time, and promote their wares accordingly. The same would happen in the UK. Knowing those refunds are landing on doormats would encourage advertisers to plug products. Those lump sums might be used to help children with university and college fees, or toward a deposit for a mortgage, or maybe a new car or a foreign holiday. It would be like a second Christmas coming to boost the economy with extra spending.

It would incorporate some flexibility, too, in that people would mind receiving a lower rebate, if this were necessary, less than they would mind a tax increase. The rebate could, if this were thought desirable, be linked to the state of the national economy. Rebates can be tweaked in innumerable ways.

There is no reason why this need would to impose additional bureaucracy costs. A conventional cut from 20% to 18% would have to be calculated so that lower PAYE rates could be applied. The rebate system would involve the same calculation, but have it paid as an annual rebate instead of by lowering monthly payment rates. Indeed, the Treasury might prefer it because they could benefit from the interest they would earn on the money until it was repaid.

The Chancellor who introduces the rebate system of lowering taxes might well incur the gratitude of taxpayers, those who would like receiving lump sums ever year. And the investment and spending they would stimulate could give the economy an extra little kick every year.