The Practicalities of Flat Tax
1. Doesn’t flat tax simply mean cutting taxes?
On the contrary, it usually involves increasing the total amount of taxation. It involves setting a single rate of income tax, which in practice is almost always lower than most of the existing graduated rates. But a lower rate does not mean a lower yield. In practice countries which have introduced flat tax have increased tax revenues.
2. Surely a flat tax will give the government less to spend on social needs?
No. It should have more to spend. A flat tax raises the tax base in three ways. Because the flat rate is low and simple, people no longer resort to complicated means of sheltering their income from tax. Out go the complex schemes under which companies trade off-shore from addresses in the Caribbean. Out go the trusts and the claims for tax allowances and write-offs. It becomes cheaper to pay the tax than to pay the accountants.
This means that more income becomes taxable. People who previously evaded tax illegally now find it more worthwhile to pay the new low rate than to risk prosecution and imprisonment. This means that much of the ‘black economy’ surfaces and is taxed.
Finally the tax base rises in a third way. Because the rates are low, the incentive to do more work, to invest, and to expand are all increased, so the size of the economy also increases as more wealth and jobs are created. And the wealth stays, too, because people find it less necessary to emigrate.
3. Won’t the poor pay more under a flat tax?
In practice, no. The threshold at which people start to pay the flat tax is set high enough to exclude low earners altogether. Only money earned above that level qualifies for the tax. The proposal made in Britain, for example, is for a threshold set roughly at the minimum wage, which is about half the average earnings. The starting threshold will vary from country to country, but the principle should be to avoid taxing low earners. Cutting them out of the tax trap will make more of them independent of the need for government social support.
4. Flat tax is just a gimmick to cut taxes for the rich, isn’t it?
Not at all. It certainly cuts the rates at which most rich people pay tax, but if done properly it should increase the amount of tax they pay in total. The high earners pay a larger total amount, but a lower proportion of their income.
There is another beneficial result. After a year or two while it beds in, the top 10 percent of earners end up paying a higher share of the total tax bill. Meanwhile low earners are mostly exempt or pay trivial amounts. This result followed the 1980s tax cuts under Reagan in the US, and under Thatcher in the UK. Flat tax will be set to achieve similar results.
5. Isn’t it fairer if the rich pay a higher proportion of their income?
No. It is fairer if the rich pay a higher proportion of the total tax bill. It isn’t the proportion of their income that matters; it is their share of the total. If we can raise more money and have richer people paying a bigger share of it, most people would call that a fairer system. It is what flat tax does.
6. Won’t a flat tax be difficult to monitor and collect?
The reverse is true. Because a flat tax system removes most of the exemptions and allowances of the graduated (progressive) system, it needs much less work to police it. The tax authorities need less information about people and their circumstances, and do not need an army of inspectors to make sure people are not making false claims.
Under flat tax the authorities only want to know how much you earn. Most of the extra information they now need becomes irrelevant since all taxpayers pay the same rate. Tax collection will be far easier to administer, and far less costly to perform.
7. Will it be difficult to define income, given all the different ways in which people can seek their rewards?
No more than at present. In fact for nearly everyone it is what they are paid by their employer or what they earn as self-employed people, and is very straightforward. The Finance Ministry will want to make sure that people are not cheating by taking their reward in other ways, but they do that already, and there would be far less reason for people to do that with a flat tax system.
In any case, income tax is only one strand of flat tax, though it is the most important one. Ideally it should be only a first step, with subsequent moves to bring down taxes on capital gains and businesses to comparable rates.
8. Perhaps flat tax works for less advanced economies, but is not appropriate to a modern, developed economy?
Not so. It has been done first in less advanced economies, but that is for political, not economic reasons. Countries whose economy is less advanced, including former communist states, do not have the long history of entrenched interest groups influencing the democratic process. Politicians in countries with a longer democratic tradition have to be careful in taking on groups which perceive benefits to themselves from progressive tax systems. Some see advantages in the exemptions and allowances which characterize progressive tax systems, and fear they might lose out on any changes.
This means that it takes political skill and leadership to bring flat tax to sophisticated economies. Once they do it, however, it will work just as well there, if not better. They usually have a more mature and efficient civil service, and a system of tax collection which maximizes collection from the tax base. They generally forfeit less tax to criminal evasion, but more to legal and complex avoidance.
The advanced economies suffer the adverse effects of high tax rates because those rates are enforced, and therefore have much to gain when they are lowered to a single flat rate. The incentive boost to economic activity is probably higher in a more developed economy. And since they have other factors which make them attractive to investors, including clear property rights and business law, the move to a low flat tax increases their attractiveness to foreign investors.
Flat tax becomes politically easier as more countries introduce it. As it spreads from the Baltic states through Eastern Europe, and is taken up by major countries such as Poland, the competitive pressure is felt to keep other countries attractive to enterprise and investment. 9. But doesn’t flat tax risk a ‘race to the bottom’ as countries compete for lower rates?
Certainly those countries which do not take it up risk being left behind in the drive to promote growth and to encourage people to put money into enterprise and expansion. But this is not a ‘race to the bottom’ but a ‘competition in virtue’ because it increases economic growth in the countries which do it. If some of them are able to do it because their partners and rivals do it first, this is a good thing and a benefit to their people.
In many cases a country which sets an initial flat tax and gains the benefit of higher tax revenues and economic growth, will be able subsequently to lower their flat rate and achieve similar success.
10. But does flat tax represent the sort of future that Europe wants for itself?
Yes, very much so. Europe cannot insulate itself from the world with high tax rates which make it an unattractive place to do business. If it does it will face economic decline and rising unemployment, as some of its members already have. European countries which tread the flat tax route will be able to combine their social spending with competitive economies which can hold their own in a global market-place. Change is in the air of Europe as people recognize how out-dated its original model is now. China and India have emerged and expanded as global players, and Europe needs to face and co-exist with the world they inhabit. Europe will not do this by the kind of tax harmonization which Brussels once thought it could impose. It can achieve it by the growth and dynamism which flat tax can bring to its economies. This is a future which Europe can join with confidence and enthusiasm.
Deregulation: What Actions Need to Be Taken
My father was a trustee of the Lancashire miners’ convalescence home, located in Blackpool. Jo Gormley, the miners’ leader – who you may recall used to tip off MI5 about the activities of Arthur Scargill – appointed his own brother (a classic example of nepotism) to run this luxurious palace, which my father would regularly visit.
Bearing in mind these memories of my youth, it was alarming to discover the fuss earlier this month that centred around the regulation of the beach donkeys in Blackpool.
Inspired perhaps by the French, the local authority has imposed a strict regulatory regime on this non-unionised pack of donkeys, which currently numbers around 200. Henceforth, all donkeys must be licensed and their owners will be subject to spot checks by inspectors throughout the summer season. They will not be allowed to work more than 48 hours a week (the same limit that would apply to their two legged owners if the European Parliament gets its way which looks increasing likely as a majority of MEPs want to overrule the opt out the British government negotiated from the EU’s 1993 Working Time Directive) furthermore, these donkeys will also be entitled to a generous lunch break, again a concept cherished by our neighbours across the Channel. On top of all this they will also have each Friday to do as they please. It would be interesting to know whether former pit ponies will be allowed to compete against them for rides.
What is distinctive about this particular regulation is that it appears to draw its authority neither from our national legislature in Westminster, nor from an EU inspired directive or regulation.
It is European regulation that shall be centred on here. In our recent Deregulation report, as part of the Road Map To Reform project, we noted that the Treasury estimates that in value terms (that is to say the cost to business) approximately half of all new legislation, with a significant impact on business, now derives from EU law. However, in Tim Ambler’s latest evidence to a House of Lords select committee inquiry, he stated that ‘the EU may only be responsible for 34 per cent of the net regulatory burden on British business’. Nevertheless, this is still a significant proportion.
Last November, at the CBI annual conference, the euro enthusiast and new Trade Commissioner Peter Mandelson, admitted that the costs associated with regulation imposed by the Commission are roughly double the economic benefits generated by the single European market. In other words, regulatory costs account for around four per cent of the EU’s gross domestic product!
Cynics – or perhaps they should be termed realists – might argue that this burden will only get worse, given politicians’ keenness on regulation as a solution to a raft of political problems. But there are also reasons to be more optimistic when considering how the Brussels regulatory machine might be brought down a gear or two.
There have been two recent, significant developments. The first is the so–called ‘Six Presidency initiative’, originally suggested by Charlie McCreevy (until the end of last year Ireland’s Finance Minister) and now the Commissioner responsible for the Internal Market. Originally referred to as the Four-Presidency initiative, but now known as the Six Presidency initiative, since Austria and Finland have signed up to it as well, this action plan makes a joint commitment to carry forward a series of reform measures aimed at tackling EU red tape. These reforms include extending the use of regulatory impact assessments (RIAs) on Commission proposals, introducing new standards for public consultation, and moving forward with the important job of culling the acquis communautaire – that is to say the accumulated regulatory rulebook, which now runs to an incredible 16,000 pages.
Charlie McCreevy told a gathering of City luminaries earlier this year that he was quite prepared to axe any EU regulations that were shown to be counter productive. Mr McCreevy was quizzed at this meeting as to how he proposed to identify suitable regulations for the bin. Essentially, McCreevy’s answer boiled down to making greater use of the regulatory impact assessment procedure – a topic on which Tim Ambler has written extensively.
Impact assessments can be arbitrary, and tweaked to justify a new regulation once there is a political commitment to go ahead with it come what may. However, the Commission’s novel willingness to review the burden associated with excessive regulation is a welcome start. I believe we need to press on this opening door, which has only just moved ajar.
In another encouraging sign, Mr Barroso’s Commission has drastically slowed the pace of new legislative activity. From now on tougher impact assessment guidelines will mean that all important EU legislative proposals will be screened for potential significant negative impacts on competitiveness. As Graham Mather, a former MEP points out, “this will give business the chance to use quantified analysis to influence new legislation. Put bluntly, if the analysis can demonstrate significant quantified costs that outweigh estimated benefits, legislation is unlikely to proceed.”
It is particularly encouraging to see that several Commissioners, looked on as dangerous liberals by the French, are keen to axe existing regulations that can be demonstrated to be damaging to business. In eurospeak this is referred to as the ‘simplification’ process. Some 20 areas have already been examined but this initiative will be stepped up significantly during the British Presidency in the second half of this year.
Under the simplification process a review will be undertaken to look at alternatives to legislation, such as self–regulation or voluntary agreements. Regulations will also be tested in terms of their effectiveness in meeting their original objectives. The simplification process will also review the more vague directives that are open to legal dispute and look at what should be done where legislation has not been implemented.
In another encouraging move, the Commission has acknowledged that there is a problem with gold plating, or what it chooses to refer to as, “member state regulatory excess”, whereby member states, sometimes for protectionist reasons, over implement EU legislation. Henceforth, the Commission says that it will have no hesitation in launching infraction proceedings against member states who adopt these practices.
There are also welcome signs that some liberal–leaning MEPs are prepared to tackle the problem of excessive regulation. For instance, Gunnar Hokmark, a Swedish MEP recently wrote a letter to the Financial Times proposing that a task force should be established by the Parliament “to unpick and terminate problematic regulations.”
So the opportunity now presents itself for think tanks, business groups and trade associations to argue their case in Brussels. The opportunity needs to be seized with gusto.
Experience suggests that one of the biggest problems with the EU is the tendency for deals to be hammered out at the last minute in order to fix a range of intractable issues. Often this comes down to crude horse trading – ‘we’ll compromise on A if we can secure agreement on B and C.’ The French seem to be past masters at this dark art, but the Brits are catching up with them.
This observation leads to the second reason to be optimistic, namely the expansion of the EU. In this respect, the French have badly miscalculated: not only do Hungarians, Poles and Estonians show little sign of wanting to learn French, they are none too keen on being saddled with the anti-business regulations that strangle jobs and hamper economic growth throughout the EU. No wonder the French are concerned about the viability of their cherished social model. This certainly explains why a new book on the dangers of Anglo–Saxon inspired liberalism has sold more than 200,000 copies – and that’s in hardback – since it was published in France.
The ten accession states, many of whom were only relatively recently freed from the yoke of Soviet centralised planning, are already beginning to demonstrate ‘liberal’ tendencies when it comes to resisting EU imposed regulation and adopting flat tax fiscal strategies. Having only just liberated themselves from unwelcome state intrusion in their business and personal lives, the last thing that Poland, the Czech Republic, Hungary or Slovakia want is a raft of EU regulatory measures forced on them by Franco–German social democrat politicians.
In this context, it is ironic that the French will probably vote no to the new EU constitution on the grounds that it is too liberal and too Anglo–Saxon in its approach while the British, if they ever get the chance to express a view, will vote no on the grounds that it is overly dominated by the Franco German social model, which provides an extended rein to their political elites to interfere and regulate our daily lives.
In the next few years more individuals and firms will begin to exploit regulatory arbitrage within the EU. For example, if one wanted to establish a financial services business within the EU but one that was not closely inspected by the regulatory authorities, Malta would be an ideal place to start a business. One might term this an EU off shore strategy – while businesses can legitimately claim that they are trading within the EU’s jurisdiction, the regulation that exists there may not be too onerous. Malta has relatively few civil servants and those on its payroll already struggle to implement the EU’s existing labyrinthine regulatory regime. The latest EU scorecard reveals that Malta has failed to implement a total of 617 directives. The same scorecard shows that France has one of the worst records for implementing EU directives into national law. Indeed, France’s record has ‘gone from bad to worse’.
The following recommendations need to be made to those who are responsible for reforming the EU regulatory labyrinths.
ß The most effective way to tackle the phenomenon of gold plating – where implementation goes far beyond the minimum necessary to comply with a EU directive – is to scrap directives (or framework laws as envisaged under the new Constitution). The EU’s legislative institutions should be required to focus on issuing clearly drafted regulations, which can be applied without further interpretation by each of the 25 member states. In conducting our research, we realised that gold plating is the inevitable result of seeking to transpose EU directives into member states’ domestic statute books. In a properly functioning single market, a regulation should be clear from the outset. If it fails to meet this test, it should be scrapped.
ß If new EU regulations can be demonstrated to pass the regulatory impact assessment hurdle, sunset clauses should be built in to review whether these regulations have achieved their stated goals, three years after they were implemented.
ß Learning from what has worked well in the US, we should oblige the European Commission to report annually to the European Parliament on the total costs and benefits associated with EU regulation. The Office of Management & Budget has reported in a similar fashion to Congress on a yearly basis since 1997.
ß Europe should establish within the Commission a regulatory oversight unit to evaluate all significant regulatory proposals. If it is to exert any influence, such a body will need to have a real decision-making authority – as with the Regulatory Oversight Office in the US. It will also require sufficient funding to perform its role and be separate from the regulatory agencies it monitors.
If Europe is to succeed in reducing the regulatory burden, we need to ensure that fewer new regulations are passed, that existing ones are rationalised, and that enforcement does not become overzealous.
Why recycling can be utter garbage
A four-year study by the Environment Agency has confirmed what many of us, with our back-of-the-envelope calculations, had already worked out: that disposable nappies are no worse for the environment than washable ones.
It might seem intuitively obvious that washables are best. You just wash and re-use them, instead of throwing them into a plastic bag and letting them mount up at landfill sites, leaking methane into the air and other unmentionables into the soil. But when the agency looked at the whole life-cycle of washables and disposables, it found “little or no difference” in the environmental impact.
After all, washing nappies requires water. You need gas or electricity to boil it. You use bleach and detergent, which goes down the drain and into our waterways.
Disposable nappies are certainly bulky to transport but the cotton in washable ones is flown here over long distances from China, Pakistan, or the United States. If you send washable nappies to the laundry, you have to think about the pollution, congestion, accidents and noise caused by the laundry van.
Add it all up, and disposables come out no worse. Which at least proves something else we had long suspected – that the armies of Real Nappy Officers appointed across the country in Gordon Brown’s public jobs binge are themselves disposable.
A lot of the modern recycling religion turns out to be pure garbage. When you’ve finished with a polystyrene cup and are about to pitch it into the bin, you probably feel faintly sinful, and embarrassed that you didn’t use one of those virtuous ceramic mugs.
Well, don’t be. It takes a lot more energy to make that ceramic mug; and then each washing uses more energy, plus water and detergent. The Canadian chemist Martin Hocking calculated that you would have to use the mug 1,000 times before the energy consumed per use fell below that of the foam cup. And of course if you break it before then, it’s no contest. And you are much less likely to pick up nasty bacteria from a foam cup.
Aluminium drink cans, though, certainly are worth recycling. Re-working the metal uses just a fraction of the huge amount of energy that is required to process bauxite into aluminium, and to mine it in the first place.
But sometimes the way we do that recycling is so wasteful it is almost laughable. My local authority has a recycling plan, so now we all have three plastic bins, which themselves are no great beautification of the environment. But the recycling commandments are complicated and people often put the wrong things in each one.
So when the dustcart comes round, the driver sits there (revving the engine, pumping out diesel fumes and holding up the traffic), while another guy sorts out our rubbish into the various compartments. Human time is a more precious resource than old bottles; but here we are, just wasting it.
Families in Mexico City throw out far more rubbish than families in the United States. That is because more of their food is unprocessed: it does not keep, and much of it is unusable. The outer leaves of American supermarket cabbage, the excess fat on the meat, or the skins of the oranges used for juicing, all go for animal feed.
In Mexico such things just rot in the rubbish: more material needs to be transported into people’s homes and then out again to the rubbish dumps.
The plastic packaging of American food also ends up in landfill but it is thin, cheap and degrades easily. William Rathje, an Arizona archaeologist who (remarkably) digs through landfill sites, reports that plastic packaging and disposable nappies together occupy less than 2pc of landfill volume.
Paper, cardboard and other supposedly eco-friendly materials don’t actually degrade well in airless dumps; plastic grocery bags are now so thin that 100 of them take up the same space as just 20 paper bags.
Juice cartons, too, take up about half the landfill space of the bottles they replaced. There was a time when bottles were expensive and we all took them back to the shop to claim our deposit. These days, we realise that by the time the bottles have been transported (diesel), washed (water, electricity) and sterilised (who knows what), it is a costly non-gain for the environment.
And what about all the trees that are cut down to make newspapers? Well again, to justify recycling you have to look at the whole life cycle of the process. Newspapers are covered in ink: getting rid of that costs money and also uses some pretty nasty bleaches.
Moreover, the more paper we recycle, the fewer trees are planted. People don’t plant trees if they cannot sell the timber. And the fewer trees we have, the less of the greenhouse gas carbon dioxide is absorbed from the atmosphere. Recycle a ton of paper and you need 17 fewer trees, which I am told would have absorbed three tons of carbon dioxide over their lives.
Experts can argue about the exact figures in each case. But the good thing the Environment Agency has done, in its laborious four-year nappy review, is to show us that things which look environmentally virtuous at first sight may well turn out to be environmentally vicious on closer inspection.
We should recycle if it is rational, not because it is a religion.
Tax is five months’ hard labour
THE average Brit spends five months of the year working for the government. From January 1st to May 31st this year, every penny you have earned has gone to the Treasury. Only from then do you start to earn money for yourself.
Each year, the Adam Smith Institute calculates the date, which we call Tax Freedom Day.
It gets worse. If you include the cost of borrowing, which future taxpayers will have to pick up, the burden is another ten days’ hard labour.
And this year you have had to work three days longer for the tax collector than you did in 2004 – and five days longer than you did in 2003.
Historically, these are big annual increases, showing just how fast taxes have been increased in order to fuel Gordon Brown’s huge expansion in public-sector jobs and spending. The bulk of this year’s rise has come from the hike in National Insurance and Council Tax. But, says the Institute, there are plenty of stealth taxes that have been creeping up too.
Where does it all go?
And where does it all go? Well, government spending has been growing much faster than inflation – from £322bn in 1997-98 to an estimated £518bn this year (2005-06) – a cash rise of 60% since Labour came to power.
The NHS budget has grown faster than any – in cash terms it has more than doubled, from £35bn when Labour took office to £78bn this year. But even on the government’s figures, nearly half the extra cash vanishes into higher cost. NHS output rose only 4.1% in 2003, the last year for which figures are available, despite an 8% increase in budget that year. NHS productivity is falling as the growth of new administrators exceeds the number of doctors and nurses being hired.
Pouring more tax money into the NHS seems to be like pouring more petrol into a rusty engine. It still doesn’t go any better. If our hard-earned cash is to do any good, we need a complete reform in how healthcare is delivered. And that goes for other services that are swamped by bureaucracy too, like schools.”
Public sector “jobs binge”
The Institute is also critical of the “public sector jobs binge” that has soaked up much of the extra cash stumped up by taxpayers. It highlights the armies of “Real Nappy Officers” whose job is to persuade us to us washable rather than the “environmentally unfriendly” disposable nappies. But a four-year study by the Environment Agency has shown that disposables are no worse for the environment than washables – proof, says the Institute, that “these Real Nappy Officers are themselves disposable”.
The same is true of the NHS “Five a Day Officers”, tasked with encouraging us to eat more fruit. Since recent studies have shown that three pieces of fruit or vegetables a day is just as good for you as five, shouldn’t these workers be volunteering themselves for 40% lay-offs, asks the Institute.
Throttling economic growth
“The fact that Tax Freedom Day is getting later in the year is worrying for another reason,” says Gabriel Stein, International Economist at Lombard Street Research, who does the number-crunching for the Adam Smith Institute. “There are signs that today’s high taxes are choking off the economic growth that is needed to sustain consumer spending – and the Chancellor’s spending too.”
Indeed, an important OECD study in 2001 showed that countries where half the national income went in taxes had output levels 13% lower than ones with just 30% tax ratios. High taxes simply reduce the incentive for people to work and to expand their businesses and boost employment.
Tax in Britain has also become very complicated, particularly with Mr Brown’s various “tax credits” which many people leave unclaimed because they do not understand them. Pensions minister Malcolm Wicks told the House of Commons in March that less than two-thirds of eligible households took up the savings credit due to pensioners.
Tax is also stealthy – the headline rate of income tax has not changed but at least 66 stealth taxes have risen, according to the Tories.
The result of all this stealth and complexity is that people do not understand just how much tax they really pay. But if we put it in terms of how many days the average person has to work solely in order to pay taxes, that brings it home to people.
This year, an average taxpayer – an average, not a super-rich taxpayer – spends five months enslaved to the Chancellor. But we are not getting value for that effort we are putting in. Surely it is time for us tax serfs to break free.
Chancellor for a day
Doesn’t that just help the rich and leave a big hole in the public finances? Well, no. As Britain and America have found after tax cuts in the past – under Coolidge, Kennedy, Reagan, and Thatcher – the rich end up paying more. When taxes are low, there is less point in avoiding or evading them, or moving abroad.
And I could scrap all the complicated allowances. The injustices of high rates have to be moderated by giving people a kickback when they save into a pension, grow old, or invest in R&D. With low rates, you don’t need the complications.
Having made taxes lower and simpler, I’d move on to make them less harmful, by exempting anyone on the minimum wage from tax entirely. Some of our poorest families pay eye-watering effective tax rates, because as well as paying tax on pitiful incomes, they lose benefits too. No wonder it pays many people to avoid taking a job.
And I wouldn’t tax savers either – we want people to invest in the economy.
It might shock the middle clases, but I would put things like higher education on a commercial footing. Universities should charge what they like in what is now a world market. If they continue to struggle under the yoke of penny-pinching politicians, they’ve had it. I would let them charge full fees but require them to set up endowment funds so the poorest students had equal access: choose on merit, help on need.
I would reform school and health finance too, in ways that would help the poor most. I’d give every parent a cheque for the cost of a state education, spendable at any school, public or private – just as in Sweden, the Netherlands, or Denmark. Like Sweden, people would be setting up new schools by the score, knowing that they are better able to attract parents, with their school cheques, than the clapped-out local-authority alternatives.
I would stimulate local democracy (and election turnouts) by making sure that what is spent locally is raised locally, instead of Whitehall calling the shots. At some point in the morning, I’d put in a call to the EU, telling them that we were going to scrap VAT and replace it with a local sales tax. The revenue exactly matches what local government spends, so that’s the end of that problem: let the local people decide what, and how much.
On central government expenditure, I would ask whether we really need Defra, at £3.1bn, or a culture ministry at £1.5bn, or a DTI that burdens industry more than helping it at £5.9bn? And I might conclude we cold also sack the Deputy Prime Minister and disperse his £5bn in tax cuts.
After lunch, I would relax and watch the investment markets boom, reflecting on the words of Henry Luttrell:
O that there might in England be A duty on hypocrisy A tax on humbug, an excise On solemn plausibilities.
And I would knock off by giving tax policy over to the Bank of England. They’ve done such a great job of taking monetary policy out of politics that surely it must be time for them to step in and take taxation out of politics too – so that taxes exist to pay for essential expenditures, rather than to help politicians win elections.
Liberate Europe from regulatory excess
In our new Adam Smith Institute study, we set out a “road map” which explains how policymakers can begin to cull the mounting stack of regulatory rules, both across the EU and within member states
We identify three main sources of regulation that impinge on UK citizens, namely, the EU, Whitehall and regulatory agencies, such as the Financial Services Authority and Ofcom. A similar position applies in other EU member states. If we are to succeed in reducing the regulatory burden, we need to ensure that fewer new regulations are passed, that existing ones are rationalised, and that enforcement does not become overzealous.
In terms of the cost to business, the Treasury estimates that over half of all new legislation with a significant financial impact on UK business now derives from EU law. If we are to lift the regulatory burden we must tackle the main engine behind its recent growth. From our analysis of the regulatory labyrinth, we concluded that a series of radical reforms were required.
First, the most effective way to tackle the phenomenon of gold plating — when implementation goes far beyond the minimum necessary to comply with a directive — is to scrap directives (or framework laws, as envisaged under the new Constitution). The EU’s legislative institutions should be required to focus on issuing clearly drafted regulations, which can be applied without further interpretation by each of the 25 member states. As we researched our report we soon realised that gold plating is the inevitable result of seeking to transpose EU directives into member states’ domestic statute books. In a properly functioning single market, a regulation should be clear from the outset. If it fails to meet this test, it should not be introduced.
Second, it is essential that we introduce regulatory impact assessments for all new EU regulations that impinge on business. Such scrutiny aims to establish whether the net benefits from a new regulation exceed the compliance costs. Our suspicion is that many do not pass this straightforward test. Indeed, Peter Mandelson, the EU’s trade commissioner, told last year’s Confederation of British Industry annual conference that the cost of EU-generated red tape was roughly double the economic benefits generated by the single European market.
Third, if new EU regulations can be demonstrated to pass the regulatory impact assessment hurdle, sunset clauses should be built in to review whether these regulations have achieved their stated goals, three years after they were implemented.
Fourth, we can reflect on the US experience and oblige the European Commission to report annually to the European Parliament on the total costs and benefits associated with EU regulation. The Office of Management & Budget has reported in a similar fashion to Congress on a yearly basis since 1997.
Fifth, we should establish within the Commission a regulatory oversight unit to evaluate all significant regulatory proposals. If it is to exert any influence, such a body will need to have a real decision-making authority (as with the Regulatory Oversight Office in the US). It will also require sufficient funding to perform its role and be separate from the regulatory agencies it monitors.
Sixth, we need to radically prune the acquis communautaire. The UK government has set out some ideas on how this could be achieved. In financial services, the EU’s Financial Services Action Plan has attracted considerable criticism. In this context, the crucial regulations that need to be simplified are the first investment directive, the capital adequacy directive and the money laundering directive.
The Six Presidency Initiative — which sets EU priorities for the next three years — claims it will seek to cull outmoded Union rules. Charlie McCreevy, the internal market commissioner, said that he was prepared to abolish legislation that had proved to be damaging. We have offered to submit a list of suitable candidates for Mr McCreevy’s attention.
The initiative should be welcome news to the 10 new accession states. Many of them were only recently freed from the yoke of Soviet central planning. Having liberated themselves from unwelcome state intrusion, the last thing they desire is a raft of EU regulatory measures imposed on them by overzealous bureaucrats.
The writer, Keith Boyfield, is the co-author with Tim Ambler of Road Map to Reform: Deregulation (Adam Smith Institute).
Why the case for a flat-tax is irresistible
So what is it? In place of the various tax bands, exemptions and allowances that feature in a progressive tax regime, flat tax replaces them with a single rate. Typically, it excludes low earners from paying any income tax at all and sweeps away the tax allowances that made the graduated system so complex.It works on two levels. The single rate is set sufficiently low that compliance shoots up. It is less worthwhile to avoid tax by complicated tax shelters and less worthwhile to evade it by criminal failure to declare income. The second effect is that the low rate increases the reward of extra effort and risk-taking. Since people can now keep a higher proportion of what they earn, extra earning becomes more attractive.
Both the higher compliance and the expansion of economic activity contribute to broadening the tax base. This explains one of the most paradoxical features of flat tax: the fact that it rapidly brings in more revenue at the lower rate. It does so because the lower rate is charged on more income.
There is another paradoxical feature. A low rate of flat tax (with low earners exempted altogether) can rapidly lead to the rich paying not only more tax, but a higher proportion of the total. Something of this effect was seen following the UK’s tax cuts of the 1980s. The top 10 per cent of earners, who had contributed 32 per cent of income tax before the cuts, were contributing 45 per cent afterwards. US tax cuts have produced similar results.
Those who talk of raising Britain’s top rate from 40 per cent to 50 per cent say they want the rich to pay more. The reality is that tax revenues from the top earners might well decrease if they did so, whereas a cut in the top rate to 30 per cent would probably increase total revenue and raise the share of it paid by the rich.
Of course, there are theoretical objections to flat tax and John Kay has raised some of them (FT Feb 9). Critics say it is difficult to define what income is and that is why we need thousands of pages of tax regulations. But the overwhelming majority of people in Britain are paid wages or salary, perhaps with a few easily quantified benefits such as subsidised meals. For all but a tiny minority, their taxable income would be obvious.
Indeed, the same difficulties apply to the present system. Income is no more difficult to define under flat tax than it is now. It is easier.
It is the high tax rates that motivate people to seek out those exemptions and to shelter some of their income behind them. This is one reason the current system has become so cumbersome and complex over the years. The change to a flat tax represents the chance to sweep away the accumulated debris that has built up within the tax system over generations, just as privatisation enabled distortions and bad practices to be discarded from our state industries.
Some critics suggest that flat tax only works in smaller, less developed or transitional economies. It is true that its practitioners include several of the former communist states of Eastern Europe. But Hong Kong is by no means a less developed economy, nor is Russia a small one, and Hong Kong has had flat tax since 1948, Russia since 2001. China, no economic midget either, is considering the idea and it is attracting increased interest in the US.
There will be huge competitive advantages to the first of the advanced European economies to follow this route. The low tax rate will prove a magnet for high flyers and for those setting up new businesses. It will certainly cost much less to administer, too. There is more to flat tax than its financial and commercial attractions, however. Simplicity itself is a virtue in taxation. It is better that people should understand their obligations than that they should not.
Flat tax promises to cut the Gordian knot of tax complexity. Those who feel comfortable in that complexity might blanch at the prospect of a tax system at once simple and transparent. If this tax system also unleashes enterprise and boosts economic growth, the case for it grows irresistible.
Flat tax is not flat earth, as John Kay suggests. Rather it is feet on the ground.
Madsen Pirie is president of the Adam smith Institute
A Tartan (Flat) Tax?
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.
The mother of all privatizations
It gave the world the concept of mass-market privatization. It bristled with marketing innovations. It sparked a revolution in share ownership. It heartened the government to privatise more. And it provided a model from which many other countries, including ex-communist ones, were happy to borrow.
Of course, the revolution started earlier, in 1979, when Margaret Thatcher’s new government inadvertently privatized British Petroleum (BP). Inadvertently, because some of BP’s shares were already in private hands, and when the government dumped a few more, its holding slipped below 50%.
Perplexed Treasury officials noted that if the government did not control a company, it could hardly be kept on the books as an asset; nor could it be subject to all the borrowing and other constraints on nationalized industries. BP had simply floated into the private sector.
But having discovered that 50% is all it takes, Thatcher’s administration cheerfully embarked on other small privatizations. In February 1981, it sold 51.6% of the state planemaker, British Aerospace. By November it was selling Cable & Wireless – a minority at first, but later, when it failed to take up a rights issue, its holding slipped to 45%, and another state enterprise floated away.
When the radio-chemicals company, Amersham International, was sold, there was another innovation. To sweeten the deal with employees, they were offered shares on a buy-one-get-one-free basis. Four out of five of them bought into it. Encouraged by that, the state trucking business, National Freight Corporation (NCC), went to Downing Street with a worker-management proposal. Some 9,000 NFC employees and 1,300 NFC pensioners chipped in an average of £700 (E1,000, $1,300) each to take it private. A shrewd investment: seven years later, that stake would be worth £7,000. Later, when the government sold 51.5% of Associated British Ports, its workers snapped up 12.2% of it.
In 1983-84, some 27 railway hotels – now among the poshest in Britain – went private. So did Jaguar, the carmaker. Sealink ferries went; and the ailing cross-Channel hovercraft service was sold to staff for £1 (they quickly turned things round and sold it on two years later for £4.3m).
But BT, in 1984, was the watershed. It was big. It would be the mother of all privatizations. It would require a £4bn flotation – which few people thought possible in a country with only 3m shareholders. It would need a massive marketing campaign – first to tell people what equities were and then to sell them a share in the company.
Culturally, that was a big shock. As one of the government’s PR advisers told me: “We met up with the London Stock Exchange (LSE) to decide how many copies of the information leaflet – telling people what shareholding was all about – we should print. The LSE said perhaps 5,000. We told them that we were thinking of an initial run of at least a million, and more later. Their faces turned white. They knew things were never going to be the same again.”
A massive television advertising campaign was launched. Ordinary members of the public were encouraged to participate through incentives such as money off their phone bills or bonus shares. And the credit-sale idea was pioneered: buyers needed to find only one-third of the share price up front, the rest payable later. But still, only Thatcher seemed confident. Just two weeks before the sale, a senior director of Kleinwort Benson, the bank chosen to handle it, gazed wistfully out of his 20th-floor boardroom window. “I’m very worried,” he confided to me, “whether this is going to work at all.”
But it did. In fact 2.4m people applied for shares, which were four times oversubscribed. The employees were cut in too, getting 4.6% of the stock. Service improved: after all, the engineer coming round to fix your phone was also a shareholder in the company. And buyers were delighted: the 50p part-paid shares quickly rose to 95p.
That sale of 20 years ago also notched up some other firsts. It introduced limited competition, in the shape of a new company, Mercury. It set up Oftel, charged with extending competition and curbing BT’s abuse of its network monopoly. It introduced the RPI-X formula, whereby BT’s prices would have to fall faster than the retail price index. Originally set at RPI-3%, Oftel soon raised the target to RPI-4.5% and by 1992 to RPI-7.5%.
Lots more followed. British Gas, valued at £5.7bn, and loaded with new debt to counteract its monopoly power. Vickers shipyards, bought by a consortium of staff and local people. Rover, the carmaker, was sold to an already privatised company, British Aerospace. The National Bus Company, was split into small units and sold mostly to management buyouts. The airports followed.
By 1987, even the famous name of Rolls-Royce was up for sale, with another innovation, the clawback. Initially, 60% of the share issue was reserved for institutional investors. But if the general public wanted more, said the government, then the City would get less. They did. The sale was oversubscribed 9.4 times, so the institutions ended up with just 49%. And there was more innovation for the 1989 and 1990 sales of water and electricity utilities – split into regional companies prior to the introduction of full-blown competition.
So by the time the Berlin Wall crumbled in 1989, the ex-communist countries had a wealth of British experience to draw on. In 1991, Czechoslovakia, with 97% of its economy state-run, soon took BT-style mass privatisation to a new level. The government encouraged the public to buy vouchers, giving them a stake in a number of new investment funds that would hold the stock of 1,491 old state industries – the idea being to spread the risk of ordinary people buying into a dud. Some 98.9% of the vouchers were taken up, and by 1998, four-fifths of state enterprises had been privatised – a remarkable turnaround in just seven years.
Bulgaria did much the same, though on a far smaller scale. Poland and Romania tried their own variants that they hoped would create more concentrated holdings in the privatised companies. Russia went for it too, with free privatisation certificates that people could put into new investment funds. But Russia had forgotten the need for public education: many people just sold their vouchers for vodka.
But despite the odd mistake, privatization has swept the world – outside Old Europe, at least. Even there, though, things are changing. A phone call from Windsor stopped Thatcher privatising the Royal Mail and it remains stuck in limbo; but Germany has sold a chunk of its postal service, as did the Netherlands. They might even buy ours, if the opportunity arose. That would be a sad reflection on how Britain’s reforming zeal now lags behind that of others. But Britain can still take heart that, exactly 20 years ago, it started the whole world revolution going.
Dr Eamonn Butler is Director of the Adam Smith Institute. This article was published in The Business newspaper on 28 November 2004.
Queen’s speech
What struck me most about the Queen’s speech was not the draconian plans to combat terrorism or crime. With an election coming up, that is just advertising. The government has plenty of powers to combat terrorism. But still feels the need to convince tabloid readers of how illiberal it can truly be.
No, the astonishing thing was how petty and technocratic were most of the 37 bills and draft bills proposed. Seven years on, and perhaps just five months until the general election cuts through the legislative programme, and what are we talking about? Cutting the number of National Lottery funds from three to one. Amalgamating existing laws on animal welfare. Making school inspections shorter. Tidying up the rules on public inquiries. Means-testing legal aid in magistrates’ courts. Boosting local government’s powers on fly-tipping and abandoned cars. Shuffling the nature and countryside agencies. Fusing the powers of the Welsh Ombudsman. Setting up a Welsh transport users’ committee.
What a truly depressing list of administrative desk-shuffling. Most of it seems aimed only to make the statue-book look a bit neater (if a lot longer, too). More (like the proposed extensions to disabled access, or increasing the penalties on in-care mobile phone use) amounts to just changing or extending measures passed in the last seven years.
Couldn’t they get it right first time? Is this dreary list really the best our national politicians can do for us?
I must admit: as a bit of a techie too, I was secretly pleased to see the plan for part-privatizing the Probation Service, though it goes nowhere near far enough. But then its chance of surviving a truncated parliamentary session is roughly zero.
And the chance of a number of other bills surviving is about zero too. Crossrail (too late, anyway, after so much prevarication, to help Britain’s 2012 Olympics bid) is clearly a gonner. I don’t hold out much hope for the bill allowing councils to provide better school transport. The Supreme Court idea might well get clogged up in the Lords, who have grave doubts about it. The plan for living wills could be just as controversial. As might the measure to test people for drugs after they have been arrested. And while the EU constitution referendum will certainly be forced through, it will provide bystanders with a great deal of amusement on the way.
So what are we left with? Gambling: a liberalization truncated after intense lobbying from the established vested interests. (So instead of competition, we’re allowing just eight super-casinos. Super-monopolies, more like.) Railways: abolishing the Strategic Rail Authority which this government created, and trying to unscramble the mess unleashed by ex-DTI minister Stephen Byers. Various other solutions to non-problems.
And, of course, the headline-grabbing measures to crack down on serious (and non-serious) crime and make us all carry ID cards. (It’s interesting that even the US, after 9/11, hasn’t chosen to adopt and ID-card scheme. But then American politicians perhaps have a greater grasp of constitutional liberties than ours.) Still, it’s all good electioneering stuff.
But what mention is there of the really deep structural dysfunctions in our public services? Enabling school heads to manage budgets over three years rather than one? How pathetic. It’s time to give heads complete control over their budgets, and their land and buildings too, and scrap the LEAs. Give parents a voucher for the cost of their kids’ education, and make schools compete for their custom. Incentivise good heads to take over failing schools. That will do more to raise the quality of sink schools than simply shifting their most disruptive pupils out to mess up the education in the good ones.
Same in health. Foundation hospitals are a central bureaucrat’s idea of freedom. Just get the Whitehall and local bureaucracy out. Empower patients with cash, competitively-provided social insurance, or savings plans along ISA lines, so that hospitals will be desperate to welcome them in, rather than treating them as a necessary inconvenience.
And tax. It’s not just become too high, it’s far too complicated. Tolley’s Tax Guide, the accountant’s bible, now runs to 7,344 pages across four volumes. So let’s follow the lead of nine other countries, including four EU members: scrap all the complicated rules, loopholes, exemptions, credits, and rebates, and introduce a flat tax. About 19% on incomes over £18,000 should do it. Since it’s not worth cheating at that rate, the rich start paying a lot more – as the other flat-taxers have found. The poor, of course, pay nothing, unlike today. And since low tax rates make work more worthwhile, you get an instant boost to economic growth.
That’s a modest programme that should be do-able between now and May 5. But it would do a lot more to change life in this country than what our tired politicians are actually proposing.
Dr Eamonn Butler is Director of the Adam Smith Institute