We saw earlier this week that the government’s mooted NICs rise to fund social care would disproportionately burden younger generations with the costs of paying for the costs of social care expansion. An alternative package involving a 1% increase in income tax rates for the over 40s and restricting Winter Fuel Payments to those on Pension Credit would raise a similar amount but leave those under 40 largely unaffected. This would be a more intergenerationally fair way of raising the revenue need to overhaul England’s social care system, but it would not be the most progressive one. Pensioners with modest incomes and full time employees over 40 earning the National Living Wage are among those who would lose out from these measures.
How could we raise revenue in a more progressive way, then? Instead of increasing existing taxes, we could examine areas that are relatively undertaxed in the current system. Land and property is one such area, particularly at the higher end. Council Tax is not only based on property values that are 30 years out of date, but tax amounts do not increase nearly in line with property values. Replacing Council Tax with a Housing Services Tax (HST) set at two-thirds of one percent of the property’s current value would increase tax revenues by approximately the same as a 1% NICs rise, our analysis shows.[_] Broadly, the impact of this reform would be to increase annual property taxes for lower-value properties in Council Tax band A, leave them roughly unchanged for those in Band B and increase them for those in higher value properties.
Those paying additional taxes would thus be owners of higher-value properties, who also tend to have higher incomes: 57% of the highest-income tenth of households would see a reduction in their post-tax income of at least 1%. But many pensioners who own property wealth but whose current incomes are lower would also lose out. In this sense, this option fulfils both objectives of both intergenerational fairness and greater progressivity. However, concerns about the impact of such reforms on this asset-rich cash-poor group are a nettle that would have to be grasped when considering these reforms (though these could be offset to some extent by allowing payment of tax to be deferred until the sale of the property or the death of the owner).
Winners and losers by household income decile from replacing Council Tax with a Housing Services Tax
Source: TBI calculations using UKMOD version A.2.5.1. UKMOD is maintained, developed and managed by the Centre for Microsimulation and Policy Analysis at the Institute for Social and Economic Research (ISER), University of Essex. The process of extending and updating UKMOD is financially supported by the Nuffield Foundation. Modelling follows method of Chapter 16.2.1 of the Mirrlees Review.
A further problem would arise given the way local government is funded and the massive variation in property values across the UK. A reform along these lines would increase the tax base of local authorities in London and the commuter belt dramatically but do little to help local authorities in the north of England. Thus, if this reform were introduced without any changes in grant funding to local authorities, those in the north would have to set the tax at a much higher percentage of property values than those in London and surrounding areas, undoing much of the effect of the reform.
Alternatively, if grants were to adjust to compensate, the size of these adjustments would be enormous. The link between higher taxes and social care spending in a particular area would thus be rather weak: the tax might be seen as a ‘tax on London’ rather than paying for social care, especially as many people living in less expensive properties elsewhere in the country would see a reduction in their tax liabilities.
What other more progressive options might there be? An obvious answer is reforms to Capital Gains Tax. Capital gains are among the least heavily taxed form of income anywhere in the tax system: they are taxed less heavily than other forms of capital income, and far less than income from work. Whereas most forms of income are taxed at rates of 20%, 40% and 45% and may be subject to NICs as well, capital gains are taxed at rates between 10% and 28% depending on the type of asset. There is therefore a strong incentive for those who are able to do so to receive remuneration in this form.
Moreover, low rates of tax on capital gains relative to other forms of income are not only a source of unfairness between people with the same level of income but a different income composition but also a source of unfairness between richer and poorer groups. Since capital gains are disproportionately received by the very richest – 90% are received by those with total income and capital gains above £100,000 – this disparity in tax treatment is of disproportionate benefit to the better off. Indeed, it lowers the average effective tax rate of those with total income and capital gains of more than £10 million to less than that of the median earner. Bringing the tax treatment of income and capital gains closer into alignment would therefore be a highly progressive reform.
Reforms to equalise the tax treatment of capital gains and income could also raise significant amounts of revenue. The IPPR has estimated that:
Aligning income and capital gains tax rates could raise £9 billion a year,
Removing the separate capital gains tax allowance a further £7 billion, and
Removing Business Asset Disposal relief a further £4 billion and
Removing the forgiveness of gains at death a further £2 billion.
Even if an indexation allowance that prevented purely nominal capital gains arising from inflation were also introduced (which would be desirable) at a cost of £7 billion, this would still raise more than the £13 billion raised by the proposed hike in NICs rates.
What both of these reforms lack, however, is a clear link between the tax rise and additional funds for social care that is more apparent with a NICs rise or a specific income tax levy. It is not immediately obvious why the less than 300,000 people who pay Capital Gains Tax each year should bear the sole burden of paying for a better social care system, for example. The response – that these individuals are currently unfairly benefiting from disparities in the tax system – may not be entirely satisfactory. Therefore, although there is a strong case for reform in both of these areas, labelling them as a way of paying for social care reform is potentially problematic.
More funding for social care is undoubtedly needed. The government’s mooted NICs rise is one way of achieving this. However, it would leave the working-age population bearing the burden of paying for an improved social care system and do nothing to address any of the many structural problems in the tax system. Tackling these problems, whether in the taxation of capital gains or property taxes, could raise the same amount in a more progressive way.