Play fair: Equalising the taxation of earned and unearned income
This report explains how the government could more fairly tax earned and unearned income:
- The current UK tax regime strongly favours unearned income over earned income. This has led to a tax system that is both unfair and inefficient. It also means that the young and those people who receive their income from employment pay much higher tax rates than those who receive unearned income
- In practice, because most private assets in the UK are held by older generations (mostly housing and pension wealth), the current tax system is intergenerationally out of step and represents an intergenerational injustice
- By equalising the taxation of all forms of income into a unified fiscally-neutral Income Tax schedule, the tax system would become more efficient, transparent, and fair both intra-generationally and inter-generationally
- There are no social or economic justifications for skewing taxation towards earned income
- Due to the welcome but challenging increase in longevity, the proportion of national income that must be spent on health, social care, and the state pension will continue to grow. Where that tax revenue comes from is increasingly an intergenerational fairness issue
- Abolishing the system of National Insurance Contributions (NICs) and incorporating the equivalent rates into a unified Income Tax schedule, alongside equalising the taxation levels on all forms of income, would lead to additional annual tax revenue of £30 billion
- The tax system is significantly fairer in most European countries – in France and Germany the tax rates on capital gains are 30% and 26% compared to the UK’s 10-20%
- Currently, a person with an income of £60,000 a year in the form of capital gains or dividends pays less tax than a person (under 65 years) earning £35,000 through employment. Earned income, in such cases, is taxed 2 – 4 times more heavily than unearned income
- Put simply, anyone with an annual income of £60,000 drawn from unearned income has a lower effective tax rate than someone (under 65 years) earning £35,000 through employment
- A graduate in employment earning £35,000 a year pays almost double the effective tax rate of someone with a rental income of £35,000 a year
- The revenue raised from equalising the taxation of earned and unearned income could be used to reduce the taxation burden on the lowest earners by increasing the personal allowance to £13,800. It would also allow for tax rates at each level to be lowered by at least 1.25 percentage points.