Flat rate seduction

The concept of a flat rate tax - an idea that is about to sweep the world according to its supporters - has a very seductive charm about it.

Everyone despairs of the complexity of tax legislation and the billions of pounds squandered in administrating it - so the idea of disbanding the Inland Revenue in favour of being able to write one's annual tax statement on the back of a small envelope sounds like a political winner.

It already is in some countries. Russia, Ukraine, Poland and Estonia are among a host of east European countries that have already adopted it and political parties in Germany and Spain are toying with it.

Countries whose economies are stagnating are very vulnerable to the discovery of an elixir that will solve all their problems with one dose. Be careful. The countries that have so far adopted a flat rate tax have mainly had special circumstances.

If economies suffer from widespread non-payment of tax such as Russia or are poised to escape from a stultifying economic inheritance (Russia and most of east Europe) then an increase in tax revenues and economic growth that was going to happen anyway, can easily be attributed to the wonders of a flat rate tax.

Beware of the snake oil salesman. Flat rate taxes are claimed to boost economies in a number of ways. First they dispense with the need for armies of tax collectors and administrators - which is fine as long as you are not running a highly complex economy such as Germany or the UK with sophisticated public services and built-in transfer mechanisms to help the poor.

Second, although they are called flat rate taxes their protagonists almost always intend to reduce the overall tax burden in the process (particularly for the rich) so they should really be called low flat rate taxes. Virtually no supporters of flat rate taxes believe in actually raising the overall burden of taxation.

There is usually a gap in their arithmetic because the effects of a general reduction in tax rates planned to accompany such schemes is magically offset by a claimed increase in tax income arising from greater entrepreneurial activity stimulated by the tax cuts.

In other words flat rate taxes are just another variant of the hoary proposition that low taxes stimulate risk taking and pay for themselves out of increased economic activity. Would it were so. If it were, Britain would be leading the world.

Over 20 years ago in Britain Margaret Thatcher's administration cut the top rate of tax from 80% to only 40% without any noticeable effect on Britain's underlying rate of growth. Moreover, this supposed righting of a wrong did not satisfy Britain's top managers (who had previously complained about the disincentive effect of high tax rates).

Instead they took this unprecedented increase in their take-home salaries as a starting gun to ask for yet more money. Even now, 20 years on, they are awarding themselves double digit pay increases at a time when average earnings have been rising by barely 4%.

This has had no measurable effect on Britain's recent economic success whose causes lie in the macro-economic stability introduced by Gordon Brown, the chancellor of the exchequer (building on a base created by the outgoing Conservative administration).

Despite this economic stability, business investment is at a worryingly low level. If businessmen can't or won't take risks by investing more at a time when their take-home pay has been rocketing, why should it be any different under a low flat-tax regime?

None of this means that a flat-rate tax should be ruled out from the start, rather anything that could simplify our excessively complex tax system should be welcomed. But it should not be taken on the word of evangelists whose main motive is to enable the rich to keep more of their gains rather than to help the poor.

Britain's position in this debate should be rather like the government's current position vis-a-vis the euro. If other countries are keen to do it let then let them go ahead and we will watch from the sidelines to see whether it is successful.

We can't judge by the exceptional circumstances of east European countries escaping from communism. But if a sophisticated country with a large welfare state with all the complications of allowances and tax credits such as Germany were to succeed, that would be different.

But we are a very long way away from that. On two previous occasions when a British government tried to introduce a flat rate tax (Mrs Thatcher's poll tax and at the time of the Peasants' Revolt in 1381) there were riots in the streets.

There is something about flat rate taxes and social justice that just do not mix.