Would a simpler tax system leave you better off?

Millions of Brits would benefit if we scrapped our current tax system and started again with a simplified version.

Last year, the latest edition of Tolley’s Tax Guide was published, covering the 2011/12 tax year.

This definitive handbook of tax legislation is a monster, having doubled in length since 1997. The latest edition weighs in at 11,520 pages, whereas Leo Tolstoy's blockbuster War and Peace comes to just 1,204 pages.

Too many taxes

After decades of clumsy fiddling by successive governments, the UK now has some of the world's most complicated tax legislation. This complex labyrinth of taxes puts a huge burden on individuals and businesses, forcing them to spend an excessive amount of time on their tax affairs.

Hence, pressure groups such as the TaxPayers' Alliance are calling for drastic measures to shorten and simplify the UK's tax code. They claim that our tax system is no longer 'fit for purpose' and is heading for collapse.

Indeed, with only the very wealthy able to afford professional advice to make full use of a mishmash of tax breaks and loopholes, it seems that our flawed tax system is damaging lives and ruining businesses!

Trim our taxes

Personally, I believe that it's high time that Britain completely overhauled its tax system, in favour of a fairer, simpler replacement. My view was reinforced earlier this month, when it took me much too long online to file the simplest of tax returns.

Most advocates of a slimmed-down tax system favour the introduction of a 'flat tax' on income and other earnings. Instead of a jumble of different tax rates and allowances, the flat tax I propose would introduce a single tax-free allowance, followed by much-simplified rates of tax covering all sources of earned income.

This would replace a horrible hotchpotch of income tax allowances, different tax bands and National Insurance contributions (NICs) with easy-to-understand taxes on earnings. However, would this be fairer, and would you be better off?

How about a £10,000 allowance?

Last week, Deputy Prime Minister and Liberal Democrat leader Nick Clegg urged the coalition government to introduce a tax-free allowance of £10,000 for income tax. For this tax year, this personal allowance is £7,475, but rises on 6 April to £8,105 for the 2012/13 tax year.

At a stroke, this step would remove several million people from the tax system, but would also reduce the government's tax take by billions, at a time when it is spending £10 billion a month more than it is earning. Thus, Mr Clegg's plans found few supporters at HM Treasury and among his Conservative partners in government.

Even so, £10,000 is a nice, round number, so I'm going to use it as the tax-free allowance for my flat-tax calculations for workers with various levels of income.

Who would be better off?

To keep things simple, I'm going to use as my test subject an unmarried employee aged under 65, who makes no pension contributions, receives no other tax allowances (such as childcare vouchers) and makes no student loan repayments in this tax year.

Here are my results, based on calculations taken from the listentotaxman.com website, plus my own flat taxes. These consist of a £10,000 tax-free allowance, followed by 30% tax on the next £40,000, and then 50% tax on any remainder above £50,000.

Salary of £10,000 a year

• Current deductions of £837.64 give you £9,162.36 in your hand.
• My flat taxes give you £10,000 in your hand, so you gain £837.64.

Salary of £20,000 a year

• Current deductions of £4,037.64 give you £15,962.36.
• My flat taxes give you £17,000, so you gain £1,037.64.

Salary of £30,000 a year

• Current deductions of £7,237.64 give you £22,762.36.
• My flat taxes give you £24,000, so you gain £1,237.64.

Salary of £40,000 a year

• Current deductions of £10,437.64 give you £29,562.36.
• My flat taxes give you £31,000, so you gain £1,437.64.

Salary of £50,000 a year

• Current deductions of £14,391.04 give you £35,608.96.
• My flat taxes give you £38,000, so you gain £2,391.04.

Salary of £100,000 a year

• Current deductions of £35,391.04 give you £64,608.96.
• My flat taxes give you £63,000, so you lose £1,608.96.

Now for the big snag!

Unless you're a really high earner with, say, a salary well on the way to £100,000 or more, then you'll be much better off with my flat taxes than under the current system of income tax and NICs.

Then again, the big problem with my calculations is that all but the wealthiest workers benefit from these flat taxes on income. Alas, there simply aren't enough high earners to balance out the national numbers. In fact, only around one in 20 workers (5%) earn more than £50,000 a year and only around one in 50 (2%) pull in six-figure salaries.

What's more, although the average wage in the UK is over £26,000 a year, this 'mean average' is inflated by a few enormous salaries. A good analogy for this would be 'a parade of pygmies and a few giants'.

For the record, roughly 70% of the UK's 29.1 million workers earn less than the mean average weekly wage of around £500. As a result, the overall tax collected under my system would be considerably lower, leading to a shortfall of tens of billions of pounds a year.

High earners would pay more

Thus, in order to balance the Treasury's books, my flat-tax rates would have to be considerably higher. Instead of rates of 30% kicking in at £10,000 and 50% at £50,000, these would probably have to rise to, say, 36% and 60% respectively.

While these tax rates sound considerably higher than what we pay at present, they aren't way out of line with the current deductions taken by income tax and NICs. Right now, almost all employees pay a combined tax rate of 32%, 42% or 52%, depending on their incomes.

In summary, for flat taxes to be a success (by freeing large numbers of workers from tax), they must impose steep tax rates on top earners. Given the outcry last year when the 50% tax rate was introduced on incomes above £150,000 a year, I suspect that this would be one step too far for wealthy members of the British establishment!

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