The British tax system should be fundamentally overhauled and replaced with a single rate on all forms of income, regardless of whether they come from labour earnings, savings, trusts, dividends or rent.
This is the recommendation put forward in a report by the Institute for Public Policy Research tackling the British tax system.
The report - called Tapering over the Tax - said the British tax system failed in being efficient, progressive and coherent.
In its place the think tank recommended that rates and allowances for employee National Insurance contributions and income tax should be combined into a single tax schedule, and applied to all incomes on an individual, annual basis.
All income would be treated under the same rates, irrespective of where it came from, the report recommended.
It also said the system of marginal tax bands should be replaced with a formula-based system, meaning tax bands would no longer exist and for most incomes the marginal rate would increase at a slow pace between a new tax-free allowance and a new threshold for the top marginal rate.
Under this system every taxpayer's marginal rate, as well as their average rate, would depend on their own precise level of income.
The report highlighted the arbitrary way in which tax can vary, with the effective rate of tax on annual earnings from employment above the tax-free allowance set at 32 per cent, compared to 7.5 per cent for income paid in dividends from company profits.
The report stated: "For income tax payers on the lowest earnings, effective marginal tax rates can be as high as 75 per cent as means-tested benefits are withdrawn as a result of higher pay.
"This variable treatment of different sources of incomes, combined with sharp 'cliffs' in the marginal rate between tax bands, creates perverse economic incentives, makes tax avoidance more likely and is far from transparent.
"Overall, the UK's tax system is not progressive. On average, the poorest 20 per cent of households pay 35 per cent of their gross income in tax, far more than the average for all other households."
One reason the current system is not progressive, the report stated, is because of tax relief on pension contributions.
The report stated that because the size of the relief is given by the marginal rate at which a pension contribution would have otherwise been taxed, higher-income individuals accrue a significantly more generous relief compared to lower-income taxpayers.
For example, a pension contribution from an annual salary worth £25,000 receives a 20 per cent tax relief, while a contribution from a salary worth more than £150,000 receives relief worth 45 per cent.
The report stated: "The effect is the inverse of whatever tax schedule is applied: the more progressive the schedule, the more regressive the relief.
"In a context of rising pressures on public spending, particularly from an ageing population, the system of taxing incomes is structured in such a way that makes raising tax rates particularly difficult.
"Variable rates for different types of economic activity, combined with abrupt cliffs in marginal rates, create clear groups of ‘losers‘ from any tax-raising proposals.
"This can also give false perceptions of how tax changes will affect different groups of taxpayers, often helping to grow political opposition to reform."
damian.fantato@ft.com
