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Lord Newby: My Lords, I thank the noble Lord, Lord Patten, for introducing this debate. This is a platitude which one always says in such a debate but in this case it is heartfelt. The Liberal Democrats, for our sins, have decided to establish a commission to look at the tax system as a whole. One of the things we committed ourselves to was to consider a flat tax. Having had a crash course in flat taxes in order to speak in this debate will give me a bit of an edge in terms of the contribution I hope to make to the commission, and I am grateful to the noble Lord for stimulating that.

In response to the noble Lord's question about whether I am an old-style or an Orange Book Liberal, some would argue that the Orange Book Liberals are really old-style Gladstonian Liberals and that it is a false choice. For most of my political career, I have been very happy to describe myself as a social democrat. I am very happy, if it helps the noble Lord in thinking about what my views might be, to consider myself a new Liberal circa 1910, but I am not sure that that will help him all that much.

As ever with taxes, even a very simple concept, as a pure, flat tax undoubtedly is, does not remain simple for very long. It is clear that the advocates of flat taxes have a variety of models and motives in mind, not least to use the flat tax as a means to reduce the overall tax burden. This was clearly a principal motive for Steve Forbes when he put forward a flat tax in his presidential campaign in 1996, and it is clearly a motive behind a recent briefing from the Adam Smith Institute on the subject. In its central proposal, it assumes that one would introduce a flat tax which would cut personal taxation by some £50 billion. Not surprisingly, it finds that nobody would lose under a flat tax in those circumstances.
 
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However, if one is serious about introducing a flat tax for the UK, one's central proposition should be that any flat tax is revenue neutral. We saw at the recent general election how very difficult it is to identify substantial savings and cuts in government expenditure which are credible and have an acceptable political price. So the rest of my remarks are predicated on the suggestion that any flat tax would be revenue neutral.

Even if you make that assumption, you have to address a number of other key issues. First, which of the existing reliefs do you abolish? For example, the Adam Smith Institute proposes to abolish the relief on personal savings—that is, ISAs—and on certain state benefits. It would abolish capital gains tax taper relief. Some of those may be good ideas, but they are big issues which would need to be seriously addressed in any proposal.

Secondly, would the flat tax apply only to personal income or would it also apply to company taxation? If you are going to introduce it, there is some logic to applying it as far across the board as you can to produce a neutrality, as it were, of tax.

We do not have time this evening to go into many of these issues, but if you were going to introduce a flat tax, and it was going to have the benefits that it is said to have, you would probably want to abolish as many reliefs as possible and apply it as broadly as you could.

Leaving that matter aside, what are the benefits of a flat tax? The noble Lord, Lord Patten, has enumerated some of them. The one with which everybody can agree is that a flat tax is simpler. I think that noble Lords on all opposition Benches would agree that the Chancellor's tinkering with the tax system, in a manner which has led to an accretion of the tax scheme, has not been beneficial to the economy and that many of the wheezes that he has introduced have been counterproductive. Therefore, any proposal that is going to bring about a great simplification deserves to be taken seriously.

It obviously flows from the fact that the flat tax is simpler that it would be less costly to collect. It would be easier for employers to do their sums; it would be easier for individuals to do their tax returns; and it would be easier for the Inland Revenue to work out what the correct amount of tax would be.

It is argued also that a flat tax would increase revenue because it would give less scope and incentive for evasion. You are reducing a top rate and you are getting rid of a lot of allowances, so it is much less easy to evade taxes. And it is argued that a flat tax would have great attractiveness to the UK because people would want to come to work and live here because the top rate would be eliminated and people would see and have a very simple tax structure. That is another potential benefit.

The flipside of making the tax system simpler is that it would become much less easy to tinker with it in future. Once you have made a great principle of simplicity, it is less easy to change that.
 
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Finally, in terms of the advantages, a flat tax would potentially take many poorer people out of income tax all together. This has long been a Liberal Democrat aspiration, but it has never been a central part of our policy because we have never been able to afford it.

Therein lies one of the problems. When one looks at the disadvantages of a flat tax, the first issue is the distributional effect. The distributional effect will depend a lot on where the threshold is set. The noble Lord, Lord Patten, suggested a significant rise in the threshold, but there is no absolute need under a flat tax to have any particular threshold at all—that is a matter of choice. If you were to raise the threshold significantly, it would undoubtedly take many lower income earners out of income tax all together. From a tax neutral perspective, it would also reduce the amount of tax paid by the rich, on the assumption that there would not be any significant behavioural changes that would bring a lot of the income on which they are currently avoiding paying tax into the tax net. You can argue about what the likely impact would be. My guess is that it would be not all that great.

However, my central assumption is that the people who would pay more would be middle class, middle-income earners, because of the large amount of people at the bottom end of the scale who have come out of the tax system all together. That is an inevitable consequence of a flat tax which is revenue neutral.

If you decided that you did not want to raise the threshold significantly, the distributional effects of a flat tax would be very different. Instead of benefiting, the poorer people would lose out and one of the main benefits of the tax would be lost.

Many of the benefits that are claimed for a flat tax are pretty illusory. It was interesting that the noble Lord referred to Estonia. A number of eastern European countries have introduced a flat tax, Latvia and Russia among them. I agree with the noble Lord on the need for a greater public policy debate in this country, but how we find the funding for that is an interesting question. Research by the Brookings Institution and the IMF on the Russian flat tax suggest that you cannot claim that the tax itself was responsible for an increased tax take, and it is very difficult to make the case that the flat tax led to greater work incentives. So I am unpersuaded of some of those alleged advantages.

One can also not avoid the question of which allowances you abolish or do not abolish. While you can have a lot of allowances, if you want, with a flat tax—and the Adam Smith Institute proposes keeping allowances for charitable donations and pension reliefs—you can equally have no allowances without a flat tax. For example, we abolished mortgage tax relief over a period; that was one of the main issues relating to the American flat tax proposal. There are a lot of allowance issues which would need to be resolved.

Out of all that—the distributional effect and the allowance issues—comes the political cost of doing it. As we found at the last general election, proposing a
 
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local income tax, which most people would have benefited from but which some people lost out to, resulted in a debate which concentrated 99 per cent on exactly who lost out. The volume created by the criticism of the losers largely drowned out the discussion of who would benefit. In a revenue neutral flat tax system many people would lose. The political climate needed for introducing a flat tax would be extremely difficult to find.

I suspect that all of us on these Benches and the Conservative Benches can agree that we need to kick start the simplification of the personal tax system. I am as yet unpersuaded that you need to do that by a flat tax system, or that the flat tax system is the best way in which to do that. But I believe that the debate on how we have a major simplification of the personal tax system is one that we must have in this Parliament.

8.9 pm

Lord Roberts of Conwy: My Lords, I congratulate my noble friend on securing this debate on the fascinating topic of flat taxes, and flat rate income tax in particular. I am not sure that I can swing the bat with the freedom and vigour that he expects of me, but I shall do my best. I begin by reminding him that at least flat taxes are not simply the theoretical curiosity they were, when they were first suggested by Robert Hall and Alvin Rabushka 20 years ago. Since then, legislation for flat taxes has been introduced, admittedly unsuccessfully, to the United States Senate—and as the noble Lord, Lord Newby, reminded us, Steve Forbes ran a campaign for the Republican presidential nomination on a flat tax policy, in 1996.

Flat taxes are spreading round the world. The Baltic states—Estonia, Lithuania and Latvia—have led the way, Russia, Serbia, Ukraine and Slovakia have followed, and Poland has recently announced plans for a flat tax of 18 per cent. Barbados, Hungary and the Czech republic are said to be considering plans for a flat tax. Even Germany, that most sclerotic of European economies, has cut its corporation tax rate to 19 per cent, and is said to have considered adopting a flat tax.

Those countries that have adopted, or are thinking of adopting, flat taxes, have their reasons, of course. First, flat taxes enhance economic freedom; they remove the behavioural effects that the complexities of the tax system cause, with its different rates and reliefs. They give people the scope to make unadulterated decisions as to how much they earn and spend, compared with how much they save. Not everyone would argue that that is a good idea; there are many ways in which governments rightly seek to influence the behaviour of citizens. That is why there is a duty on tobacco, alcohol and petrol. But the current Chancellor of the Exchequer has introduced, as we have heard, a multitude of credits and complications to the tax system to manipulate the behaviour of British people. Those could be reduced without necessarily going down the road towards a flat tax.
 
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Proponents of flat taxes have a second argument, which is related to the first but broader, that a flat tax would simplify the tax system. Steve Forbes famously argued that tax return forms could be reduced to the size of a postcard. After considering a few further arguments for flat taxes, I shall argue that there is much that we can do to simplify the current tax system without necessarily adopting a flat tax.

The third argument put for flat taxes is that such reforms would remove the double taxation of savings. Flat taxes would prevent people being taxed on their earnings and then taxed again on the interest from investing those earnings. But, of course, not all interest is taxed; despite the Chancellor's abolition of dividend tax credits, interest from tax-efficient savings accounts such as ISAs, remain untaxed. There are ways of reducing taxation on savings without resorting to flat taxes. However, there is no question but that we need to encourage savings. The savings ratio has fallen by a third under this Government and our pension system is in crisis. Before the general election the Conservative Party consulted on proposals to reduce the burden of taxation on savers, such as through introducing a lifetime savings account, and to encourage pension saving.

Other arguments for flat taxes rely on the suggestion that they would reduce the tax burden. A flat-rate tax even with a substantial personal allowance would significantly cut taxes on high earners. The belief is that, in line with the theories of Dr Arthur Laffer, this tax cut would stimulate the economy and would encourage people to work harder and more productively and to invest more in productive businesses. Investment would also be drawn in from abroad, and the result would be an upturn in economic growth.

Two effects are suggested. First, flat taxes would not necessarily be regressive if middle and high-income earners worked harder because their taxes were cut; they would end up paying as much tax as under the current system. I am sure that noble Lords are aware of the work of Mr Richard Teather, the associate senior lecturer in tax law at Bournemouth University, who recently carried out research for the Adam Smith Institute. He argues that in the United Kingdom a flat rate of 22 per cent with a personal allowance of £12,000 would benefit most of those on just below average incomes. The poorest third would benefit more than the richest third. The poorest 10 per cent would benefit by 9 per cent of their income; the richest decile by just 1.4 per cent. And 10 million people would be removed from the income tax net. I am sure that noble Lords are aware of his work because that figure of 10 million has been mentioned more than once.

The second suggested effect of increased economic activity resulting from a flat-rate tax is that tax revenues need not fall. If people earn more, they will pay more tax. Teather claims that, under his proposals for a 22 per cent flat tax in the United Kingdom, increased economic growth would make up for initial losses in tax revenue within three years.

Those claims are often backed up using the success of tax cuts in Britain and America during the 1980s under Ronald Reagan. The top rate of tax in America was cut
 
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from 70 per cent to 28 per cent. Growth averaged 4 per cent a year. Under Margaret Thatcher, my noble friend, the top rate of tax in the United Kingdom fell from 83 per cent to 40 per cent. Per capita GDP rose by 24 per cent. However, I would remind your Lordships that neither the noble Baroness nor Reagan introduced a flat tax; they simply reduced taxes.

It would also be wrong to suggest that the economic success stories of Britain and America were due solely to tax cuts. But there is no doubt that low-tax economies are the most successful economies the world over. They generate more wealth and create more jobs. That is why the Conservative Party proposed tax cuts of £4 billion before the general election and why we would have reduced borrowing by £8 billion to avoid the tax rise that it appears the Government will shortly have to introduce.

Unfortunately, under this Government the trend is towards a higher and not a lower tax economy. They have introduced 66 tax rises since they came to power and the average household pays £5,000 more tax a year than it did in 1997. I am in no doubt that this trend should be reversed for the sake of the British economy. It is no wonder that productivity growth has fallen by a third, that we have the biggest trade deficits since the 17th century and that Britain has slipped from fourth to eleventh in the World Economic Forum's international competitiveness league. But I think it is important to recognise that the benefits of a lower-tax economy could be secured without necessarily resorting to flat tax.

I return to the topic of tax simplification on which I think we are all agreed. The tax system has become more complex especially in recent years in terms of the weight and size of tax legislation and the guides written to assist people or business that need to understand it. The number of pages in the Finance Act averaged 346 from 1987 to 2003. The 2004 Finance Act was 634 pages long. The cost of administering the system has grown. Membership of the Chartered Institute of Taxation has grown by 42 per cent in the past decade. The Inland Revenue's budget has doubled in real terms in the five years to 2004. All that gives us some idea of the growth in the complexity of the UK tax system. It is riddled with inconsistencies, complexities and obsolete provisions that impose considerable burdens on taxpayers, businesses and Her Majesty's Customs and Revenue.

Had the Conservative Party won the election we would have established a simplification project to run alongside the current Tax Law Rewrite Project. We would also have introduced a tax structure review programme to look into existing tax legislation, to identify measures to be modified, approved or abandoned.

Tax simplification can be achieved without the "big bang" approach of introducing a flat tax. But the Government must have the will to achieve such simplification. On current form it appears that they lack such will.
 
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8.21 pm

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