Lawson’s tax model is broken – Labour should restore progressive tax

In the run-up to this week’s budget, Lords Lawson and Lamont loudly led a campaign for a significant raising of the upper 40% income tax band from the current £41,450 of taxable income.

It’s a question worth raising. But we need to recognise that, like other parts of the Thatcher-Reagan ‘trickle-down’ economic theory of the 1980s, the Lawson income tax settlement has now broken down under its own inherent flaws. And their solution today is as wrongheaded as Lawson’s original ‘simplification’ of income tax bands to a basic rate of 25% and upper rate of 40%.

Labour should pledge to return to a truly progressive tax system that they abandoned. Not only would the reintroduction of the 10% tax band for those on Minimum Wage make sense, but the introduction of a 30% tax band would restore the progressive principle.

Initially we should set it from the 40% ‘cliff-edge’ at £40,000 up to £50,000. But the key principle is that the top 20% should all pay some tax at a higher rate. There should be no returning to the punitive tax rates of the 1960s – but progressive tax should be part of a fair deal for all.

Let’s remember their own legacies as Chancellors; of rip-roaring inflation, a housing market bubble, eye-watering interest rates, recession, rocketing unemployment, a humiliating Sterling crash and devastation of local government finance through the Poll Tax fiasco. They give no reason for the current or future Chancellor to listen to them.

But their analysis that a far larger number of taxpayers – 4.4 million in 2012-13 according to the Treasury’s February 2014 paper on UK tax liabilities – are paying the higher rate than in 1988 when the number was just 1.35 million, is correct.

What Lord Lawson did in his 1988 budget was effectively to abandon the principle of progressive income tax and introduce the neo-conservative fantasy of flat rate tax – because only 5% of taxpayers would pay the single higher rate. Subsequent reductions in the basic rate to 20% under Conservative and Labour governments widened the gulf between the two tax bands to the widest in Europe.

The Coalition government’s policy of aggressively increasing personal tax allowances to over £10,000 on the face of it is a progressive tax measure taking nearly 2 million people out of income tax altogether (though not National Insurance, and benefiting also higher earners). But the effect of these radical changes – which have made the UK a tax-haven by OECD standards with the average rate of income tax paid in 2013-14 estimated at just 17.6% – has been to skew and narrow the income tax collection base and render it more volatile.

Progressive tax systems help the economy as a whole. The correlation between greater income inequality and declining growth rates is now widely accepted. The contribution of the move away from financing of public expenditure from progressive income tax to indirect taxes and duties, which disproportionately hit those in the lowest 10% of income has been part of this socio-economic problem.

But the absence of progressive income tax banding also strengthens the perception of the highest earners that they are being milked: there is a psychological ‘falling off a cliff-edge’ in suddenly jumping from a marginal rate of 20% to 40%, and the top 10% of tax-payers now account for 55% of all income tax collected.

It is difficult to see how we can reduce the numbers paying income tax while reducing the deficit, increasing state pensions and maintaining a basic level of public services. While Labour has already promised to reintroduce the 50% top rate of tax as a measure of social equity and to finance vital measures to combat youth unemployment, calling time on the crude 20 & 40% tax band system is surely overdue.

Tom Brown is a Committee member of Labour in the City and former managing director at NordLB