Thursday, 7 August 2014

What is hourly averaging?

Hourly averaging is the primary idea presented in Rethinking Taxation, so it is probably a good idea to set out briefly what this means. Hourly averaging is a new way to work out what tax-rate people should pay. The best available basis on which to determine someone's tax rate is their lifetime average hourly income.

It therefore rivals proposals that calculate the tax rate based on the value of a particular transaction (such as most duties and consumption/sales/ excise taxes). The main rival, however, is the idea that the total amount that someone receives in a year is the appropriate determinant of someone’s tax rate (as with income tax). 

A year or longer?

Hourly averaging alters this annual taxation in two opposite directions. On the one hand the horizon of the tax is increased from a single year to the lifetime of the individual. So instead of treating each year’s income separately in calculating tax, all the taxpayers’ income is included. This is not a novel proposal: the idea of multiple year tax averaging and its logical extension of lifetime averaging are longstanding proposals.

There are several advantages to having a longer period. One is that it avoids an arbitrary point in the year around which people might organise their affairs for the sole aim of minimising their tax bill. Even more importantly, it gives a better idea of how economically fortunate the taxpayer is. Some people spent many years developing skills and then earn a lot for them later. Others might have very fluctuating income. A highly progressive tax system would tax these people a lot during their good years but not take account of the less good ones. 

Averaging by time or by hours worked?

The innovation comes in the other part of hourly averaging. Instead of dividing the income by the number of years that have passed, I propose to use hour credits as the denominator. People would receive hour credits for a number of reasons, but the archetypal source of an hour credit is that someone has performed an hour of work for their employer. The employer would inform the tax authority of the work done, and this would be included in their tax calculations from then on.

What are the benefits?

Calculating tax on a lifetime basis using hour credits allows for highly progressive tax rates. High rates can be applied to those with a high hourly average income. Furthermore, negative hourly tax rates can provide a powerful earning subsidy to those who have a low hourly average income. This means that a lot of revenue can be generated from the most economically fortunate (those who make use of their talents or position to earn economic rents) and shared to those who work hard but for low pay. No other proposal promises to do this.

Using hours in the calculation provides a strong incentive for people to work more that progressive taxes can otherwise remove. Everyone would want more hour credits. After all, this would reduce their tax-rate for any given amount of income. Hour credits would effectively represent additional income to their recipients; each person would know that they receive x amount of money whenever they get an additional hour credit. This means that people will have a strong incentive to work longer, counteracting the common complaint that taxing the fortunate and assisting the less fortunate discourages people from working.

Hourly averaging is a proposal that utilises the advantages of the market economy such as the incentives to produce and consume in the most efficient way. However, it counteracts the inequities that market economies perpetuate; that some do very well while others struggle.

You can find out more about hourly averaging from my book 'Rethinking Taxation' or by looking through more of my blogs. If you have any thoughts please leave a comment below or send me a direct message.

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