Category: Economics: Ch 23

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ISA Reform: Will it boost the London Stock Exchange (LSE)?

For a while now, debate has raged over how to revive the fortunes of the London Stock Exchange (LSE). Since the 2008 financial crisis, the market has suffered a lack of investment, poor liquidity and low performance. This has produced a moribund financial market which has become unattractive to both investors and companies. Returns from the UK market lag international competitors, particularly the USA (see the chart).


Investment in the S&P 500 Index over the period would have produced annualised rates of return of 14.35%, more than double that from the FTSE 100 Index. Part of this underperformance is due to the industrial mix of the listed companies: low-growth energy and mining compared to the high-growth technology sectors in the USA. This has led to the perception that London is not a place for firms to list, particularly those in high-growth sectors.

In 2024, 88 companies choose to delist or transfer their primary listing elsewhere. Only 18 took their place. Several big companies from a range of industries, including Ashtead, Flutter and CRH have transferred their primary listing to New York or have plans to do so.

The new Labour government views stimulating higher levels of investment though the London market as an important element in its drive to boost productivity and growth in the UK. Recently, it has been reported that investment institutions have been lobbying the UK government to reduce significantly the tax-free allowance for Cash Individual Savings Accounts (ISAs) as a way to encourage more of UK households’ savings to be channelled through the UK stock market.

Currently, UK savers can save up to £20 000 annually into ISAs without paying tax on the interest earned. This can be held solely in Cash ISAs, or in a combination of Cash plus Stocks and Shares ISAs. The tax-free instruments which were introduced by a Labour government in 1999 to encourage higher savings have proved immensely popular. Data from Paragon Bank indicate that over £350 billion are held in these accounts. However, under the new proposals, the amount which would be allowed to be saved as cash has been rumoured to be cut to £4000 per year, with the hope that some of it will be invested in the UK stock market.

The proposals have proved controversial, with high-profile figures voicing opposition. In this blog, we’ll analyse the reasons behind the proposal and discuss whether it will have the desired effect of stimulating higher levels of investment. We’ll also discuss other proposed policies for making the LSE a more effective channel for investment flows to boost economic growth.

Stock markets and the saving and investment channel

The main reason for the proposed ISA change is to encourage more investment in the UK stock market. By reducing the amount which can be saved in Cash ISAs, the government hopes to encourage savers to invest in Stocks and Shares ISAs instead, particularly ones linked to the UK market. This would increase the amount of finance capital in the market, thereby boosting its liquidity. This would then make it an attractive place for young, vibrant UK and foreign companies to list.

An active, liquid secondary market in shares is important to attract firms to list on stock exchanges by issuing shares to outside investors. Traditionally, this channel has been important to the growth and development of firms.

Existing savings in Cash ISAs are deposited with financial institutions such as banks and building societies. Through the credit-creation process such funds can be used to finance productive investment. In countries like the UK, lending by financial institutions is an important way that investment is financed, particularly for small and medium-sized enterprises. However, scale limits, regulatory restrictions and the need to diversify lending properly means that there are limits to the financing available for company investment through these institutions.

Capital markets like the LSE are intended to meet these larger-scale requirements. Financial claims, such as debt and equity, are divided into atomised instruments and sold to outside investors to fund investment and business growth.

Further, the desire for a capital injection to finance growth is not the only reason that firms seek stock market listings. Founders of companies may have a lot of wealth invested in the equity of their firms. Selling some of their equity to outside investors through a stock market listing is a way of diversifying their wealth. However, if they are to maximise the potential sale price, there must be an active, liquid secondary market to encourage investors to buy shares in the primary market.

Proponents of reform want to encourage a greater appetite for risk among UK investors, which will produce more savings being channelled through the LSE.

One issue is whether savers will respond in the way anticipated and channel more funds through the UK stock market. Many savers like the security of Cash ISAs. Such vehicles offer a low-risk/low-return combination, which savers like because the tax benefits boost returns. A survey by the Nottingham Building Society found that a substantial number of Cash ISA savers are concerned that the proposed changes could affect their ability to save for important financial goals, such as buying a house or building an emergency fund. Higher-risk Stocks and Shares ISAs are not suitable for such savings because of the potential to lose the initial amount invested. Many may not be prepared to do so and one-third suggested they would save less overall.

According to the survey, only 38% of Cash ISA holders said they would consider investing in Stocks and Shares ISAs if the Cash ISA allowance were reduced. It may be difficult to alter such risk-averse preferences given the average amount saved through ISAs and demographics. In 2022/23, the average amount subscribed to ISAs was £5000. This does not suggest that average households have a significant surplus of cash that they may want to investment at a high risk through the stock market. Indeed, many may want to have access to the cash at short notice and so are not prepared to forgo liquidity for the time needed to accrue the benefits of compounding which stock market investing produces.

Demographics may also play a role in this. Many of those who save more are now retired, or near retirement. They are less likely to see the appeal of compounding returns over long periods through investment in shares. Instead, with shorter investment horizons, they may only see the potential for losses associated with Stocks and Shares ISAs. Indeed, they will be starting to liquidate their long-term positions to draw income in retirement. Therefore, they may save less.

For others, who may be prepared to accept the additional risk, with the prospect of higher returns in the way that advocates of the reform hope for, the reduction in the Cash ISA allowance does not necessarily mean that they will invest in Stocks and Shares ISAs linked to the UK market. Since returns from the UK market have lagged international competitors, it may be that savers will channel their savings to those international markets, particularly in the USA, where the risk–return relationship has been more rewarding. Doing so has been made much easier and cheaper through a combination of economic forces including technological advances, regulatory changes and increased competition. This makes it much easier for UK savers to channel investment funds to wherever potential return is highest. At the moment, this is unlikely to be the UK, meaning that the anticipated boost to investment funds may not be as much as anticipated.

Critics of the proposal also question the motives of investment fund managers who have been lobbying government. They argue that the reforms will mean that many people who do now choose to save in Stocks and Shares ISAs will buy funds managed by fund managers who will receive fees for doing so. Critics argue that it is the prospect of higher fees which is the real motive behind the lobbying, not any desire to boost investment and growth.

What alternatives are available to boost the London Stock Exchange

The low valuations of LSE-listed companies compared to their international counterparts, particularly those in the USA, has discouraged growing firms from listing in London. To address this, there have been calls to enhance corporate governance standards and reduce regulatory burdens for listed companies.

This has already been recognised by the authorities. In 2024, UK regulators approved the biggest overhaul of rules regulating London-listed companies. The new listing rules will hand more power to company bosses to make decisions without shareholder votes. They will give companies more flexibility to adopt dual-class share structures used by founders and venture capital firms to give themselves stronger voting rights than other investors. This is particularly popular for founders who want to diversify their wealth without sacrificing control and is used frequently by tech companies and venture capitalists when listing in the USA. Such reforms may attract more companies in high-growth sectors to list in London.

Tax policies which provide the right incentives to buy and sell shares could also encourage more investment in the LSE. For instance, the repeal in the mid-1990s of the preferential tax treatment of dividend income for UK pension funds and insurance companies is seen as a major factor in discouraging those institutions from investing more funds in the London market. Since tax on capital gains is only liable when they are realised, this reduces their present value versus the equivalent amount on dividends.

As the following table illustrates, given the significantly higher percentage of total returns derived from dividends in the LSE compared to other exchanges, the equal tax treatment of dividend and capital gains provides an incentive to seek jurisdictions where capital gains predominate. This is what UK pension funds have done. Data from the Office of National Statistics show that in 2024, 77% of UK occupational pensions equity investments were overseas.

Reinstating this tax benefit could stimulate greater demand for UK equity from this significant sector, boosting liquidity in the London market. Allied to this are proposals from the UK government to consolidate the fragmented UK pension industry to achieve greater scale economies in that channel for investment. This can reduce financing costs, boosting the marginal return from UK investments for these funds, encouraging greater investment in the UK market (ceteris paribus).

Further, the 2.5% stamp duty on share purchases has been viewed as another disincentive for both retail and institutional investors to engage in security trading on the London Stock Exchange. The duty, which is much higher than in peer economies, effectively raises the expected rate of return on UK equites which depresses perceptions of their values and prices. Its removal may raise trading volumes, improving the liquidity of the market and be offset by increased tax revenues in the future. However, the Treasury suggests that the removal of stamp duty is doubtful, since it would create a significant hole in the UK government’s budget.

Ultimately, many of these reforms may have limited impact on investment. Efforts to boost confidence in the stock market will depend on improving the overall economic environment in the UK. Therefore, it will be the wider policies promoting growth in general which will increase the rates of return offered by London-listed firms and be more significant to attracting capital to London.

However, many of these are controversial themselves, such as relaxing laws around planning permissions and addressing business uncertainties around post-Brexit trading arrangements with the European Union. These broader economic measures could help make the UK generally, and the LSE specifically, more appealing to both domestic and international investors.

Conclusion

The UK government’s proposal to reduce the Cash ISA allowance is part of a broader strategy to boost investment in the stock market and stimulate economic growth. While this change could lead to more capital being directed towards productive investments, it also poses challenges for savers who like the security and simplicity of Cash ISAs.

The ultimate impact will depend on how savers respond to these changes. The potential reduction in overall savings rates could counteract some of the intended benefits. Further, the extent to which they are prepared to channel their savings into UK-listed companies will be important. If many seek higher returns elsewhere, the impact on the UK stock market may be limited. In any case, policies to address the problems of the UK stock market will only work if the wider issues associated with UK productivity and growth are addressed.

Articles

Data

Questions

  1. Explain how banks use cash ISAs to finance investment through credit creation.
  2. What do stock markets offer which may boost investment and economic growth?
  3. What are the issues with the London Stock Exchange which is making it unattractive for raising finance?
  4. How is the rumoured ISA reform intended to help address these issues?
  5. Analyse the extent to which it will do so.
  6. How might some of the broader reforms proposed by the UK government influence rate of return on UK equities and attract capital?
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Investment set to fall as business is baffled by Trump

Economic growth is closely linked to investment. In the short term, there is a demand-side effect: higher investment, by increasing aggregate demand, creates a multiplier effect. GDP rises and unemployment falls. Over the longer term, higher net investment causes a supply-side effect: industrial capacity and potential output rise. This will be from both the greater quantity of capital and, if new investment incorporates superior technology, from a greater productivity of capital.

One of the biggest determinants of investment is certainty about the future: certainty allows businesses to plan investment. Uncertainty, by contrast, is likely to dampen investment. Investment is for future output and if the future is unknown, why undertake costly investment? After all, the cost of investment is generally recouped over several months or year, not immediately. Uncertainty thus increases the risks of investment.

There is currently great uncertainty in the USA and its trading partners. The frequent changes in policy by President Trump are causing a fall in confidence and consequently a fall in investment. The past few weeks have seen large cuts in US government expenditure as his administration seeks to dismantle the current structure of government. The businesses supplying federal agencies thus face great uncertainty about future contracts. Laid-off workers will be forced to cut their spending, which will have knock-on effect on business, who will cut employment and investment as the multiplier and accelerator work through.

There are also worries that the economic chaos caused by President Trump’s frequent policy changes will cause inflation to rise. Higher inflation will prompt the Federal Reserve to raise interest rates. This, in turn, will increase the cost of borrowing for investment.

Tariff uncertainty

Perhaps the biggest uncertainty for business concerns the imposition of tariffs. Many US businesses rely on imports of raw materials, components, equipment, etc. Imposing tariffs on imports raises business costs. But this will vary from firm to firm, depending on the proportion of their inputs that are imported. And even when the inputs are from other US companies, those companies may rely on imports and thus be forced to raise prices to their customers. And if, in retaliation, other countries impose tariffs on US goods, this will affect US exporters and discourage them from investing.

For many multinational companies, whether based in the USA or elsewhere, supply chains involve many countries. New tariffs will force them to rethink which suppliers to use and where to locate production. The resulting uncertainty can cause them to delay or cancel investments.

Uncertainty has also been caused by the frequent changes in the planned level of tariffs. With the Trump administration using tariffs as a threat to get trading partners to change policy, the threatened tariff rates have varied depending on how trading partners have responded. There has also been uncertainty on just how the tariff policy will be implemented, making it more difficult for businesses to estimate the effect on them.

Then there are serious issues for the longer term. Other countries will be less willing to sign trade deals with the USA if they will not be honoured. Countries may increasingly look to diverting trade from the USA to other countries.

Video

Articles

Data

Questions

  1. Find out what tariffs have been proposed, imposed and changed since Donald Trump came to office on 20 January 2025.
  2. In what scenario might US investment be stimulated by Donald Trump’s policies?
  3. What countries’ economies have gained or are set to gain from Donald Trump’s policies?
  4. What is the USMCA agreement? Do Donald Trump’s policies break this agreement?
  5. Find out and explain what has happened to the US stock market since January 2025. How do share prices affect business investment?
  6. Which sector’s shares have risen and which have fallen?
  7. Using the Data link above, find out what has been happening to the US Policy Uncertainty Index since Donald Trump was elected and explain particular spikes in the index. Is this mirrored in the global Policy Uncertainty Index?
  8. Are changes in the Policy Uncertainty Index mirrored in the World Uncertainty Index (WUI) and the CBOE Volatility Index: VIX?
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A four-day week – a solution to sluggish productivity growth? (Updated)

In a blog from March 2023 (reproduced below), we saw how there has been growing pressure around the world for employers to move to a four-day week. Increasing numbers of companies have adopted the model of 80% of the hours for 100% of the pay.

As we see below, the model adopted has varied across companies, depending on what was seen as most suitable for them. Some give everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis. Firms adopting the model have generally found that productivity and revenue have increased, as has employee well-being. To date, over 200 employers in the UK, employing more than 5000 people, have adopted a permanent four-day week.

This concept of 100-80-100, namely 100% of pay for 80% of hours, but 100% of output, has been trialled in several countries. In Germany, after trials over 2024, 73% of the companies involved plan to continue with the new model, with the remaining 27% either making minor tweaks or yet to decide. Generally hourly productivity rose, and in many cases total output also rose. As the fourth article below states:

The primary causal factor for this intriguing revelation was simple – efficiency became the priority. Reports from the trial showed that the frequency and duration of meetings was reduced by 60%, which makes sense to anyone who works in an office – many meetings could have been a simple email. 25% of companies tested introduced new digitised ways of managing their workflow to optimise efficiency.

Original post

In two previous posts, one at the end of 2019 and one in July 2021, we looked at moves around the world to introduce a four-day working week, with no increase in hours on the days worked and no reduction in weekly pay. Firms would gain if increased worker energy and motivation resulted in a gain in output. They would also gain if fewer hours resulted in lower costs.

Workers would be likely to gain from less stress and burnout and a better work–life balance. What is more, firms’ and workers’ carbon footprint could be reduced as less time was spent at work and in commuting.

If the same output could be produced with fewer hours worked, this would represent an increase in labour productivity measured in output per hour.

The UK’s poor productivity record since 2008

Since the financial crisis of 2007–8, the growth in UK productivity has been sluggish. This is illustrated in the chart, which looks at the production industries: i.e. it excludes services, where average productivity growth tends to be slower. The chart has been updated to 2024 Q2 – the latest data available. (Click here for a PowerPoint of the chart.)

Prior to the crisis, from 1998 to 2006, UK productivity in the production industries grew at an annual rate of 6.9%. From 2007 to the start of the pandemic in 2020, the average annual productivity growth rate in these industries was a mere 0.2%.

It grew rapidly for a short time at the start of the pandemic, but this was because many businesses temporarily shut down or went to part-time working, and many of these temporary job cuts were low-wage/low productivity jobs. If you take services, the effect was even stronger as sectors such as hospitality, leisure and retail were particularly affected and labour productivity in these sectors tends to be low. As industries opened up and took on more workers, so average productivity rapidly fell back. Since then productivity has flatlined.

If you project the average productivity growth rate from 1998 to 2007 of 6.9% forwards (see grey dashed line), then by 2024 Q3, output per hour in the production industries would have been 3.26 times higher than it actually was: a gap of 226%. This is a huge productivity gap.

Productivity in the UK is lower than in many other competitor countries. According to the ONS, output per hour in the UK in 2021 was $59.14 in the UK. This compares with an average of $64.93 for the G7 countries, $66.75 in France, £68.30 in Germany, $74.84 in the USA, $84.46 in Norway and $128.21 in Ireland. It is lower, however, in Italy ($54.59), Canada ($53.97) and Japan ($47.28).

As we saw in the blog, The UK’s poor productivity record, low UK productivity is caused by a number of factors, not least the lack of investment in physical capital, both by private companies and in public infrastructure, and the lack of investment in training. Other factors include short-termist attitudes of both politicians and management and generally poor management practices. But one cause is the poor motivation of many workers and the feeling of being overworked. One solution to this is the four-day week.

Latest evidence on the four-day week

Results have just been released of a pilot programme involving 61 companies and non-profit organisations in the UK and nearly 3000 workers. They took part in a six-month trial of a four-day week, with no increase in hours on the days worked and no loss in pay for employees – in other words, 100% of the pay for 80% of the time. The trial was a success, with 91% of organisations planning to continue with the four-day week and a further 4% leaning towards doing so.

The model adopted varied across companies, depending on what was seen as most suitable for them. Some gave everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis.

There was little difference in outcomes across different types of businesses. Compared with the same period last year, revenues rose by an average of 35%; sick days fell by two-thirds and 57% fewer staff left the firms. There were significant increases in well-being, with 39% saying they were less stressed, 40% that they were sleeping better; 75% that they had reduced levels of burnout and 54% that it was easier to achieve a good work–life balance. There were also positive environmental outcomes, with average commuting time falling by half an hour per week.

There is growing pressure around the world for employers to move to a four-day week and this pilot provides evidence that it significantly increases productivity and well-being.

Additional articles

Original set of articles

Questions

  1. What are the possible advantages of moving to a four-day week?
  2. What are the possible disadvantages of moving to a four-day week?
  3. What types of companies or organisations are (a) most likely, (b) least likely to gain from a four-day week?
  4. Why has the UK’s productivity growth been lower than that of many of its major competitors?
  5. Why, if you use a log scale on the vertical axis, is a constant rate of growth shown as a straight line? What would a constant rate of growth line look like if you used a normal arithmetical scale for the vertical axis?
  6. Find out what is meant by the ‘fourth industrial revolution’. Does this hold out the hope of significant productivity improvements in the near future? (See, for example, last link above.)
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Is a flat-rate income tax a good idea?

At an event at the London Palladium on 6 December staged to protest against elements in the recent Budget, the Conservative leader, Kemi Badenoch, was asked whether she would introduce a flat-rate income tax if the Conservatives were returned to government. She replied that it was a very attractive idea. But first the economy would need ‘rewiring’ so that the tax burden could be lightened.

A flat-rate income tax system could take various forms, but the main feature is that there is a single rate of income tax. The specific rate would depend on how much the government wanted to raise. Also it could apply to just income tax, or to both income tax and social insurance (national insurance contributions (NICs) in the UK), or to income tax, social insurance and the withdrawal rate of social benefits. It could also apply to local/state taxes as well as national/federal taxes.

Take the simplest case of a flat-rate income tax with no personal allowance. In this system the marginal and average rate of tax is the same for everyone. This is known as a proportional tax.

Most countries have a progressive income tax system. This normally involves personal allowances (i.e. a zero rate up to a certain level of income) and then various tax bands, with the marginal rate rising when particular tax thresholds are reached. In England, Wales and Northern Ireland, there are three tax bands: 20%, 40% and 45%. Thus the higher a person’s income is, the higher their average rate of tax.

A regressive tax, by contrast, would be one where the average rate of tax fell as incomes rose. The extreme case of a regressive tax would be a lump-sum tax (such as a TV or other licence), which would be same absolute amount for everyone liable to it, irrespective of their income. This was the case with the ‘poll tax’ (or Community Charge, to give it its official title), introduced by Margaret Thatcher’s government in 1989 in Scotland and 1990 in the rest of the UK. It was a local tax, with each taxpayer taxed the same fixed sum, with the precise amount being set by each local authority. After protests and riots, it was replaced in 1993 by the current system of local taxation (Council Tax) based on property values in bands.


Figures 1 and 2 illustrate these different categories of tax: see Figure 11.12 in Economics, 12th edition. (Click here for a PowerPoint.) Income taxes in most countries are progressive, although just how progressive depends on the differences between the tax bands and the size of personal tax-free allowances. A flat-rate income tax with no allowances is shown by the black line in each diagram, the slope in Figure 1 and the height in Figure 2 depending on the tax rate.

Arguments for a flat-rate income tax

Generally, arguments in favour of flat-rate taxes come from the political right. The two main arguments in favour are tax simplification and incentives.

Advocates argue that a flat tax system makes tax collection easier and makes tax evasion harder. If there are no exemptions, then it can be easier to check that people are paying their taxes and working out the correct amount they owe. It is argued that, in contrast, high tax rates on top earners can encourage tax evasion.

Flat taxes can also be part of a drive to reduce the size of the informal economy. As the VoxEU article states:

Unlike progressive taxes, which include complex and numerous exceptions left to the tax collectors’ discretion, the flat tax is clear cut. In combination with the low rate, its simplicity considerably reduces the stimuli for being informal.

Several post-communist countries in Eastern Europe adopted flat taxes, but for most they were seen as a temporary measure to reduce the informal sector and clamp down on tax evasion. Most have now adopted progressive taxes, with the exceptions of Bulgaria and until recently Russia.

The second major argument is that lower taxes for higher earners, especially for entrepreneurs, can act as a positive incentive. People work harder and there is more investment. The argument here is that the positive substitution effect from the lower tax (work is more profitable now and hence people substitute work for leisure) is greater than the negative income effect (lower taxes increase take-home pay so that people do not need to work so much now to maintain their standard of living).

Then there is the question of tax evasion. With high rates of income tax for top earners, such people may employ accountants to exploit tax loopholes and hide earnings. This could be seen as highly unfair by middle-income earners who are still paying relatively high rates of tax. Even though a move to flat taxes is likely to mean a cut in tax rates for high earners, the tax take from them could be higher. There is evidence that post-communist and developing countries that have adopted flat taxes have found an increase in tax revenues as evasion is harder.

The Laffer curve is often used to illustrate such arguments that high top tax rates can lead to lower tax revenue. Professor Art Laffer was one of President Reagan’s advisers during his first administration (1981–4): see Box 11.3 in Economics, 11th edition. Laffer was a strong advocate of income tax cuts, arguing that substantial increases in output would result and that tax revenues could consequently increase.

The Laffer curve in Figure 3 shows tax revenues increasing as the tax rate increases – but only up to a certain tax rate (t1). Thereafter, tax rates become so high that the resulting fall in output more than offsets the rise in tax rate. When the tax rate reaches 100 per cent, the revenue will once more fall to zero, since no one will bother to work. (Click here for a PowerPoint)

However, as Box 11.3 explains, evidence suggests that tax rates in most countries were well below t1 in the 1980s and certainly are now, given the cuts in income tax rates that have been made around the world over the past 20 years.

Arguments against flat-rate income taxes

The main argument against moving from a progressive to a flat-rate income tax in an advanced country, such as the UK, is that is would involve a large-scale redistribution of income from the poor to the rich. If the tax were designed to raise the same amount of revenue as at present, those on low incomes would pay more tax than now, as their tax rate would rise to the new flat rate. Those on high incomes would pay less tax, as their marginal rate would fall to the new flat rate.

If a new flat-rate tax in the UK also replaced national insurance contributions (NICs), then the effect would be less extreme as NICs are currently initially progressive, as there is a personal allowance before the 8% rate is applied (on incomes above £12 570 in 2024/25). But above a higher NI threshold (£50 270 in 2024/25), the marginal rate drops to 2%, making it a regressive tax beyond that level. Figure 4 shows tax and NI rates in England, Wales and Northern Ireland for 2024/25. (Click here for a PowerPoint.)

Nevertheless, even if a new flat-rate tax replaced NICs as well as varying rates of income tax, it would still involve a large-scale redistribution from low-income earners to high-income earners. The effect would be mitigated somewhat if personal allowances were raised so that the tax only applied to mid-to-higher incomes. Then the redistribution would be from middle-income earners to high-income earners and also somewhat to low-income earners: i.e. those below, or only a little above, the new higher personal allowance. If, on the other hand, personal allowances were scrapped so that the flat tax applied to all incomes, then there would be a massive redistribution from people on low incomes, including very low incomes, to those on high incomes.

One of the arguments used to justify a flat-rate tax is that its simplicity would ensure greater compliance. But in an advanced country, compliance is high, except, perhaps, for those on very high incomes. Most people in the UK and many other countries, have tax deducted automatically from their wages. People cannot avoid such taxes.

As far as the self-employed are concerned, they file tax returns online and the software automatically works out the tax due. There are no complex calculations that have to be performed by the individual. There is come scope for tax evasion by charging various expenditures to the business that are really personal spending, but the tax authorities can ask for evidence and sometimes do, with penalties for false claims.

What tax evasion does take place, could still do so with a flat tax. At a rate of, say, 20%, it would still be financially beneficial for a dishonest person to lie if they could get way with it.

Conclusions

If the government did try to introduce a flat-rate income tax, there would probably be an outcry. Also, as some rich people would gain a very large amount of money, the number of people gaining would be lower than the number losing if the total revenue raised were to remain the same. In other words, it would be politically difficult to achieve if the number of losers exceeded the number of gainers.

It is true that if the top rate of income tax were very high, then reducing it might bring in more revenue. But at 45%, or 47% if you include NICs, the top marginal rate in the UK is relatively low compared with other countries. In 2024, the UK had the second lowest top rate of tax out of Western European countries (behind Norway and Switzerland) and only the 16th highest out of 33 European countries when Central and Eastern European countries are also included (see the final ink below under ‘Information’). Reducing the UK’s top rate would be unlikely to bring in more revenue and would redistribute income to high-income earners.

Articles

Information

Questions

  1. Distinguish between progressive, proportional, regressive and lump-sum taxes. Into which of these four categories would you place (a) VAT, (b) motor fuel duties, (c) tobacco duties, (d) road-fund licence, (e) inheritance tax? Where the answer is either progressive or regressive, how progressive or regressive are they?
  2. What are the income and substitution effects of changing tax rates?
  3. Explain the Laffer curve and consider whether it is likely to be symmetrical.
  4. Discuss the desirability of having a flat tax set at a relatively high rate (say 25%) with tax-free personal allowances up to the level of income considered to be the poverty threshold. (In the UK the poverty threshold is often defined as 60% of median income.)
  5. In the London Palladium event where Kemi Badenoch stated that flat taxes were a very attractive idea, she also said that ‘We cannot afford flat taxes where we are now. We need to make sure we rewire our economy so that we can lighten the burden of tax and the regulation on individuals and on those businesses that are just starting out, in particular’. What do you think she meant by this?
  6. Find out what Bulgaria’s experience of a flat tax of 10% has been.