Rethinking Taxation: Insights from the Mirrlees Review Presented to Fundación Ramón Areces

1. Presentation to Fundacion Ramon Areces Tax By Design: The Mirrlees Review Paul Johnson 25/09/2014

2. The review • Five year programme of work led by Prof Sir James Mirrlees • Built on a large body of economic theory and evidence. • Inspired by the Meade Report on Taxation. • Commissioned papers on all the main topics, with commentaries, collected in Dimensions of Tax Design. • Published Tax by Design in 2011

3. The need for the review • More than 30 years since the Meade review • Most advanced countries raise somewhere around £4 in every £10 earned in the economy in tax • This inevitably has big effects on the economy, on inequality, on people • There is far too little high quality debate • Governments do not tend to formulate tax strategy explicitly • Evaluation is almost unheard of • (Big) mistakes happen • There is huge scope to make the system simpler, fairer and more efficient

4. What we did (and didn’t) do • Based on economic theory • Determinedly empirical • Looking at long term solutions • A direction for reform, not a blueprint for tomorrow

5. What we did (and didn’t) do • Based on economic theory • Determinedly empirical • Looking at long term solutions • A direction for reform, not a blueprint for tomorrow • We did not take a view on the “right” • Level of tax • Degree of redistribution • Rather ask what is the most efficient structure for any required level or degree of redistribution

6. What we did (and didn’t) do • Based on economic theory • Determinedly empirical • Looking at long term solutions • A direction for reform, not a blueprint for tomorrow • We did not take a view on the “right” • Level of tax • Degree of redistribution • Rather ask what is the most efficient structure for any required level or degree of redistribution • We did not explicitly address the (hugely important) political barriers to rational change

7. Some examples of bad policy in the UK • Look at this marginal rate structure

8. Income tax and employee NICS marginal rates 2015-16 (married, non-working spouse, 2 children) Notes: Marginal rate of income tax and employee’s National Insurance Contributions. Thresholds are expressed in 2014-15 prices using the CPI. Assumes employee contracted into State Second Pension.

9. Some examples of bad policy in the UK • Look at this marginal rate structure • Capital Gains Tax at 10% while top income tax rate was 40% • Huge avoidance opportunities

10. Some examples of bad policy in the UK • Look at this marginal rate structure • Capital Gains Tax at 10% while top income tax rate was 40% • Huge avoidance opportunities • Zero rate of corporation tax for small businesses (briefly) • Mass incorporation

11. Some examples of bad policy in the UK • Look at this marginal rate structure • Capital Gains Tax at 10% while top income tax rate was 40% • Huge avoidance opportunities • Zero rate of corporation tax for small businesses (briefly) • Mass incorporation • Tax rates on employees, self employed, companies still very different

12. Some examples of bad policy in the UK • Look at this marginal rate structure • Capital Gains Tax at 10% while top income tax rate was 40% • Huge avoidance opportunities • Zero rate of corporation tax for small businesses (briefly) • Mass incorporation • Tax rates on employees, self employed, companies still very different • Property taxation based on 1990 values

13. A progressive, neutral system:

14. A progressive, neutral system: • Works as a system • E.g. corporate and personal taxes should fit together • Not every tax needs to achieve everything

15. A progressive, neutral system: • Works as a system • E.g. corporate and personal taxes should fit together • Not every tax needs to achieve everything • Is broadly neutral • Doesn’t discriminate between similar activities except under very limited conditions

16. A progressive, neutral system: • Works as a system • E.g. corporate and personal taxes should fit together • Not every tax needs to achieve everything • Is broadly neutral • Doesn’t discriminate between similar activities except under very limited conditions • Achieves progressivity as efficiently as possible

17. The rest of the presentation • Will provide a broad outline of conclusions about each part of the system • Will then focus on taxation of earnings and of capital income • Will try to draw out the important links between them

18. What we have • Does not work as a system • Lack of joining up between income tax and NI • Personal and corporate taxes

19. What we have • Does not work as a system • Lack of joining up between income tax and NI • Personal and corporate taxes • Is not neutral where it should be • Inconsistent savings taxes with normal return often taxed • Corporate tax system that favours debt over equity

20. What we have • Does not work as a system • Lack of joining up between income tax and NI • Personal and corporate taxes • Is not neutral where it should be • Inconsistent savings taxes with normal return often taxed • Corporate tax system that favours debt over equity • Is not well designed where it should deviate from neutrality • A mass of different tax rates on carbon • Failure to price congestion properly

21. What we have • Does not work as a system • Lack of joining up between income tax and NI, • Personal and corporate taxes • Is not neutral where it should be • Inconsistent savings taxes with normal return often taxed • Corporate tax system that favours debt over equity • Is not well designed where it should deviate from neutrality • A mass of different tax rates on carbon • Failure to price congestion properly • Does not achieve progressivity efficiently • VAT zero rating a poor way to redistribute • Taxes and benefits damage work incentives more than necessary

22. Our proposals • Treat the system as a whole • Integrating NI and income tax • Aligning tax rates across employment, self employment and profits

23. Our proposals • Treat the system as a whole • Integrating NI and income tax • Aligning tax rates across employment, self employment and profits • Move towards neutrality • Widening the VAT base • Not taxing the normal return to capital

24. Our proposals • Treat the system as a whole • Integrating NI and income tax • Aligning tax rates across employment, self employment and profits • Move towards neutrality • Widening the VAT base • Not taxing the normal return to capital • Whilst proposing sensible deviations from neutrality • Imposing a consistent tax on GHG emissions and on congestion • Imposing zero rate of VAT on childcare

25. Our proposals • Treat the system as a whole • Integrating NI and income tax • Aligning tax rates across employment, self employment and profits • Move towards neutrality • Widening the VAT base • Not taxing the normal return to capital • Whilst proposing sensible deviations from neutrality • Imposing a consistent tax on GHG emissions and on congestion • Imposing zero rate of VAT on childcare • Achieve progressivity through the direct tax and benefit system • Recognising constraints imposed by responses to incentives • Taking account of lifetime welfare

26. Earnings taxes should be progressive, coherent and reflective of behavioural responses • Move to a transparent and coherent rate schedule • Introduce a single integrated benefit • Ensuring benefits fit together • Reducing administrative burden and complexity • Reducing the marginal rates faced by some low earners • Focus on strengthening work incentives for those who are most responsive: • Those aged 55 to 70 • Those with school age children

27. Earnings taxes should be progressive, coherent and reflective of behavioural responses • Move to a transparent and coherent rate schedule • Introduce a single integrated benefit • Ensuring benefits fit together • Reducing administrative burden and complexity • Reducing the marginal rates faced by some low earners • Focus on strengthening work incentives for those who are most responsive: • Those aged 55 to 70 • Those with school age children • Merge income tax and NICs

28. The normal return to saving should not be taxedfull labour income tax rate should be applied to above normal returns • Returns on ordinary interest bearing accounts should be excluded from tax altogether • Current expenditure tax basis of pension taxation should be maintained • A rate of return allowance should be available for substantial holdings of risky assets • Tax rates on income and capital gains should be equalised • We would like these reforms to be accompanied by a more effective tax on wealth transfers

29. Indirect taxes should be applied much more uniformly • Remove nearly all zero and reduced rates of VAT • with a compensation package that addresses work incentives as well as distributional concerns

30. Indirect taxes should be applied much more uniformly • Remove nearly all zero and reduced rates of VAT • with a compensation package that addresses work incentives as well as distributional concerns • Replace current property taxes with a single tax proportional to property value • and based on current price

31. Indirect taxes should be applied much more uniformly • Remove nearly all zero and reduced rates of VAT • with a compensation package that addresses work incentives as well as distributional concerns • Replace current property taxes with a single tax proportional to property value • and based on current price • Introduce a tax equivalent to VAT on financial services

32. Environmental taxes should be focussed on the underlying externality • There should be a consistent price on carbon emissions • through an extended EU ETS and a tax on other emissions • Congestion charging needs eventually to replace most of current fuel duty

33. Environmental taxes are also a mess Implicit carbon taxes, 2009-10(Excluding VAT subsidy of domestic energy)

34. Business taxes should lead to neutrality between sources of finance and income • An Allowance for Corporate Equity would align treatment of equity and debt finance • Treatment of employment, self employment and corporate source income should be aligned • Tax on business property should be replaced by a land value tax

35. These are radical changes • A strategy for the long term • Involving a lot of winners and losers • And much work to be done

36. These are radical changes • A strategy for the long term • Involving a lot of winners and losers • And much work to be done • But the potential gains are enormous

37. Some big messages for policymakers • Always think about the system as a whole • Don’t deviate from neutrality unless there is a very clear reason • Hurdles need to be high

38. Some big messages for policymakers • Always think about the system as a whole • Don’t deviate from neutrality unless there is a very clear reason • Hurdles need to be high • Always use good evidence on behavioural effects • And evaluate policy

39. Some big messages for policymakers • Always think about the system as a whole • Don’t deviate from neutrality unless there is a very clear reason • Hurdles need to be high • Always use good evidence on behavioural effects • And evaluate policy • Be clear what redistribution you want • Think about the lifecycle

40. Some big messages for policymakers • Always think about the system as a whole • Don’t deviate from neutrality unless there is a very clear reason • Hurdles need to be high • Always use good evidence on behavioural effects • And evaluate policy • Be clear what redistribution you want • Think about the lifecycle • Recognise economic change • And the role of particular groups of taxpayers

41. Some big messages for policymakers • Always think about the system as a whole • Don’t deviate from neutrality unless there is a very clear reason • Hurdles need to be high • Always use good evidence on behavioural effects • And evaluate policy • Be clear what redistribution you want • Think about the lifecycle • Recognise economic change • And the role of particular groups of taxpayers • Don’t succumb to the tyranny of the status quo

42. Some specifics • Taxation of earnings • Capital taxation

43. Taxation of earnings • Should be transparent, coherent and progressive • Should be designed in light of understanding the shape of the income distribution and responses to work incentives • Direct tax/benefit system should do much of required redistribution

44. Taxation of earnings • Should be transparent, coherent and progressive • Should be designed in light of understanding the shape of the income distribution and responses to work incentives • Direct tax/benefit system should do much of required redistribution In designing the system we must account for: • Key margins of adjustment to tax reform • Measurement of effective tax rates • The importance of information and complexity • Evidence on the size of responses • Implications from theory for tax design

45. Average EMTRs for different family types

46. Average PTRs for different family types

47. Key facts • Taxes reduce labour supply • The substitution effect dominates • This is especially important for low earners • Responses are greater at the extensive margin (whether or not to work at all) than at the intensive margin (how many hours to work) • Interactions with the benefit system create great complexity

48. The interaction between taxes, tax credits and benefits Notes: Lone parent, with one child aged between one and four, earning the minimum wage (£5.80 per hour), with no other private income and no childcare costs, paying £80 per week in rent to live in a council tax Band B property in a local authority setting council tax rates at the national average

49. Key facts • Taxes reduce labour supply • The substitution effect dominates • This is especially important for low earners • Responses are greater at the extensive margin (whether or not to work at all) than at the intensive margin (how many hours to work) • Interactions with the benefit system create great complexity • Response are largest for • Women with school age children • 55-70 year olds

50. Employment for men by age, FR, UK and US 2007 Blundell, Bozio and Laroque (2011)