Going flat out

Lobbying for an overhaul of the tax system by the adoption of a controversial system of "flat tax" has been a staple of the US political right for some time. The subject had failed to generate much enthusiasm in the political mainstream on this side of the Atlantic, but that may be changing. A recent article in the Spectator by the now shadow chancellor George Osbourne championed a "flat tax revolution" in Britain, citing its successful adoption in Estonia and Russia. This week the Treasury unearthed a 32-page internal briefing on flat taxes. The memo described flat taxes as having "all the costs of reform but few of the benefits", which is harsh criticism for a system recently deemed "simpler, fairer and better" by the Economist. But the fact that the memo was written at all shows the subject is being taken seriously.

The notion of a flat tax is based on a simple premise: charge a single tax rate on all personal income. It eliminates complexity and bureaucracy, a welcome reform considering people were complaining about taxes well before Adam Smith called them "an unnecessary trouble, vexation and oppression". Supporters boast that tax returns could be done on the back of a postcard. Both Conservatives and Liberal Democrats have attacked current tax legislation, which has ballooned to over 11,000 pages, and formed commissions to study the idea.

Estonia was the first to adopt a flat-tax regime in 1994, and 11 countries now operate with some version. After switching, these countries boast higher tax revenues and lower taxpayer angst - important benchmarks of success for any tax reforms. Flat tax fans stress that these countries can still have low rates. Russia and Ukraine levy 13% on all personal income. In Estonia the rate is 24% and Lithuania has a far higher 33%. But before putting a "flat tax now" poster in your window, consider that eastern European economies are very distinct from western European ones. Higher tax revenues in Russia and Estonia are more likely to have come from reforms and improved collection, coupled with rapid growth in their economies. Eastern Europe's tax collectors were able to start from scratch, without the complications of Britain's established system of tax. For example, what would happen to VAT and national insurance? Would a flat tax only be levied on personal income or on business receipts as well? And what counts as income - does it include both salary and capital income? A simple idea quickly becomes complicated.

But the debate about flat taxes boils down to equality. Flat taxes would effectively give generous tax breaks to high income earners, who in the UK pay a 40% top rate. In contrast, those on lower incomes, with tax rates starting at 10%, would pay higher rates under flat tax. In this country consumers are also taxed through VAT, and since lower income households spend a larger slice of their income on goods and services, they pay proportionally more VAT than the better off. Under a flat-tax system, low income earners would be hit twice. Proponents of flat tax, such as the Adam Smith Institute, argue personal allowances could be used to aid those on lower incomes. This would essentially make taxes progressive at the lower end. But it is redundant and costly. The Treasury calculated that a flat tax with generous personal allowances would cost £50bn a year. In Britain, with its strong welfare provisions, using allowances could become complex and bureaucratic, meaning that the only people who would enjoy simplified taxes would be those in higher income brackets. Yet as with some once-controversial big ideas of the past - such as central bank independence - it would be a mistake to dismiss flat taxes too lightly. The subject needs a stern critical examination in case Britain considers picking up the iron and flattening its tax rates out.