Costing the CLIPH-rate tax

A significantly new public policy proposal such as the CLIPH-rate tax raises a lot of questions about costs and implications. I therefore think it sensible to answer some questions about this. Indeed, it would have been good to have provided this as an appendix to the book, and I would like to do so in any future editions if possible.

As I make clear in Rethinking taxation, there would be a transition period between the existing system and the CLIPH-rate tax. Raising funds for the transition could be done through temporary borrowing or a temporary wealth tax. However, the permanent costs are no doubt more interesting and important.

It is difficult to do a serious job of calculating the costs of a major economic policy change such as hourly averaging. The change would impact prices and choices throughout the entire economy. Some people would work more while others will work less. People will do different jobs, companies will change the way they produce. Some things would get cheaper, others more expensive. Furthermore, there is no prospect of introducing the CLIPH-rate tax in the short-term and the economy could be quite different anyway by the time it is introduced.

Nevertheless, it is no doubt useful to some sceptical readers to indicate how public finances would be allocated differently in a CLIPH-rate tax world, albeit by making some huge assumptions along the way. Indeed, there are a lot of options that I leave open for further consideration in Rethinking Taxation, and the chosen path on these issues will impact upon public spending—such as whether to bring government pension payments into the system or not.

When considering tax and benefit policy changes it is common to assume that total revenue and/or spending will remain the same. This makes sense as fixing one element makes it easier to see the real impact of the policy, though it is obviously quite artificial.

I will use the UK budget as a starting point, as it is the system I know the best as a UK citizen. In some cases it does not really matter that much which government agency undertakes a particular activity, as long as it is undertaken. So, for example, tax fraud detection could be undertaken by the police, the tax authority, or a specialist department. No doubt it will make sense for the tax authority to perform this, but given that tax evasion may go with other forms of crime close working with other crime-related departments will make a lot of sense.

The CLIPH-rate tax will take over from many existing taxes and spending areas and so this would need to be taken into account. Hourly averaging would, I assume, replace Income Tax and National Insurance. It would also take over Tax Credits, the Universal Credit, disability / incapacity benefits, unemployment benefits and Josbeekers Allowance. It could also take over pension payments, though I will ignore this possibility here and assume public pensions remain the same.

Tax revenue changes

How would the composition of tax revenues change? The CLIPH-rate tax would combine income taxes, taxes on investment income and capital gains taxes. If revenues were sufficient it could allow the removal of consumption taxes (sales taxes and Value Added Tax) and corporation taxes. I will assume that these would be maintained to the extent that it would be necessary to keep revenues the same.

The CLIPH-rate tax would of course bring some major changes. Tax revenues from low earners would drop substantially, and I will assume in this model that greater revenues from above-average earners and recipients of substantial gifts and inheritances would largely make up for this.

As the CLIPH-rate tax is a lifetime tax the revenue might not be as consistent as the current system. In the short-medium term there would be a large rise in revenues from gifts and inheritances. I suggest these should be invested in a sovereign wealth fund as they will be required in the long term as the benefactors gradually receive enhanced net incomes as they obtain more hour credits. The SWF would be used to ensure that government revenues are consistent.

The SWF will of course receive returns from its investments, which is a further gain within the CLIPH-rate tax system, though one I will ignore here. 

Public spending with neutral revenue

I think it would be reasonable to assume that the CLIPH-rate tax could raise more public revenue than rival tax systems without damaging economic development. This is because many people would be working more hours, increasing the size of the economy and reducing the cost of many items. If people were spending less on what they would purchase anyway, they will have more money to save or spend elsewhere. This in turn will increase the size of the economy.

Nevertheless, I will assume here that public spending will be roughly neutral. So the question is how to re-allocate a fixed budget for the UK of roughly £731 billion (Sources for rough and rounded figures are the National Audit Office, gov.uk and UK Public Spending). I will now outline the major changes in how revenues would be spent.

What government functions will cost more under the CLIPH-rate tax? The administrative costs would no doubt be higher, as the tax authority would require more information, and greater efforts would need to go into tax and hour credit fraud detection.

However, these fraud-detecting efforts would bring savings elsewhere. Making criminal activity more difficult would have numerous benefits, such as reduced security and insurance costs, and perhaps a reduction in the harms caused by criminal enterprises. The corresponding benefits could be substantial and impossible to quantify. One clear consequence for the public finances would be a reduction in compliance and fraud detection costs that are currently borne by other agencies (mostly the police).

In the above example the tax authority would take on work currently being done by other departments. There are other roles that could simply be transferred in the same way. The CLIPH-rate tax would combine several existing systems into one. (This is happening to a degree with the Universal Credit in the UK, though the CLIPH-rate tax would do so in a more comprehensive manner that would not suffer from the same difficulties).

I will now consider groups of people would receive greater income through the tax system than they do currently and whether this would be covered by directly re-allocating existing spending from elsewhere or whether it would require additional spending.

I would propose that carers receive payment via the hour credit system and this would be an additional expense. It is difficult to anticipate the costs without undertaking some serious analysis. Some of this could be found from existing care expenditure, which mostly undertaken on a local level by social services. Furthermore, hour credits for those looking after children would replace the existing child allowances and child tax credits. I should think that the credits for caring for children would be roughly cost neutral, while the credits for caring for the elderly and disabled would be more costly.

I also propose that students should receive hour credits, which would replace the student loan system. I assume that students would pay fees, particularly if they qualify for valuable hour credits in exchange for their studies. As students would get income from hour credits they would need smaller student loans if these were even required at all. As the hour credit payments would effectively subsidise the higher education sector there may be scope to transfer some Higher Education spending along with spending on student loans into the hourly averaging system.

Another proposal I make is for a guaranteed job scheme. Administering such a scheme would be another expense, and this would replace the existing jobseekers provisions. The unemployed would qualify for more generous support if they partake in the scheme, which would cost more. On the other hand, we can expect unemployment to drop substantially for two reasons: 1) there would be a much lower minimum wage so employers with work that could be done could offer jobs much more readily than they do, and 2) The existence of the work programme would mean that leisure-advantages of being unemployed would disappear. What this does mean is that the costs will be displaced, as I will now discuss.

The vast majority of additional spending for the CLIPH-rate tax would come from the earning subsidies that it provides to people who work a lot of hours at a low rate. This replaces the existing tax credits, but I would expect hourly averaging to be more generous.  If wages were allowed to drop below the previous minimum amount (and then did so) then this would also increase the cost of subsidising earnings.

There are around 1.5 million people working in jobs at the minimum wage or a little above. Some of these jobs would pay more in a world with hourly averaging world while some would pay less. Many of those in minimum wage work will receive tax credits as things stand, and tax credits would be calculated quite differently. People would have a strong incentive to work longer hours, whereas existing tax credits can give people an incentive to work part-time.

It is much harder to guess the amount of spending required to cover the additional negative hourly tax payments. Some people who would receive benefits in the existing system may not qualify for subsidies due to their higher income in previous years (for example from gifts or inheritances or past high-paid work). However, many will be entitled to more. The subsidy rates would need to be set in such a way that the amount of additional spending would not vastly exceed current spending on tax credits. Nevertheless, I would expect that the spending would be greater than that on tax credits.

The additional expenses that are not immediately accounted for by switching expenditure for the same purpose from one department to another is therefore the increased administrative and anti-fraud costs, the additional spending to support carers, and the extra funding for hourly subsidies for those who work long hours at low wages. The latter cost would be largest.

Where would this come from? The easiest answer for me is to claim that the greater economic activity engendered by hourly averaging would mean that the economy would be very successful and everything including the public finances would improve. However, let us assume that economic activity remains at broadly the same level.

The choice of what other forms of expenditure to cut would be a very political one. Personally, I would suggest reducing tax preferential treatment of savings, pensions and charitable deductions to raise additional revenue. This would not save enough and so a large amount of the difference would need to come from reducing other forms of subsidy from the welfare budget. Housing benefit is an obvious choice as we could hope that the reduction in inequality and greater spending power for the low-waged would remove the need for such large housing subsidies.

In other states where there are no items like housing benefit that would be less important with the application of hourly averaging, the additional funds may have to be found from other sources. Alternatively, the existing public spending could be maintained and the additional funds covered by greater economic activity or because the CLIPH-rate tax is able to raise more tax revenue than the taxes it replaces.

The above discussion is very broad and vague, but I am afraid a highly detailed breakdown of public revenue and spending would be rather pointless. The CLIPH-rate tax is not going to be introduced in the short-term and the economy will be different in the future making current spending figures outdated. Similarly, introducing the CLIPH-rate tax would cause significant changes to the economy as well. This makes current revenue and spending levels would need to be revised. Nevertheless, I have now given some idea of the shifts in public finances that would accompany my proposals.