As asset and income inequality increases for millions of households across the country, taxing consumption directly can help reduce deepening disparities of wealth, according to a new report published by the National Institute of Economic and Social Research (NIESR) with support from the abrdn Financial Fairness Trust.
We find that a direct progressive consumption tax (PCT) could be implemented without a loss of tax revenue and that it can be modelled in such a way as to reduce inequality.
A properly designed PCT enhances welfare in three ways. First, it helps households to smooth their consumption over the life cycle. It evens out consumption over time because it allows individuals to earn and save during their working life without tax disincentives and plan smooth consumption paths over their lifetime. Furthermore, progressive taxes on consumption only set in once a certain threshold is reached (e.g., a tax-free threshold of £100 per week), which enables low-income households to consume more of their income.
Second, a PCT enables households to make more flexible decisions about the balance between labour and leisure by incentivising employment for all households, not only low-income households but also higher income ones because they are taxed more on what they consume than what they earn. Third, a PCT enables households to accumulate wealth because it generates incentives to increase saving for all income groups.
Other key points include:
With tax-free consumption up to £100 per week, a PCT supports higher consumption early in life when households tend to have lower incomes but higher needs (e.g., the costs of housing and child-rearing).
While increasing hours worked by about 1.5 per week between the ages of 25 and 55, a PCT reduces hours worked before the age of 25 and from the age of 55 onwards.
Seeing the tax-free threshold at £100 per week allows households in the bottom 20 per cent of the income distribution to respond to savings incentives and increase their assets while also benefitting from bequests at prevailing rates of inheritance tax.
Transition issues from the current to a new system can be addressed by phasing in gradually a PCT, which would help people who maintain a high level of consumption from inherited capital, and by allowing for exemptions, especially tax-free thresholds.
Dr Larissa Marioni, Senior Economist at NIESR, said
“Deep disparities across households with diverse demographics and socio-economic endowments, and associated spatial inequalities are a pervasive and persistent reality in the country. Progressive consumption taxes can serve as a potent policy tool to address these inequalities, by placing more agency upon individuals and households as to when in life they wish to work, how much they would like to work, and when they would take breaks for education and retraining”.
Professor Adrian Pabst, NIESR’s Deputy Director for Public Policy, said:
“Faced with increasing inequality, it is time to reform the UK tax system that is not working for millions. But as recent events have shown, we need policies that make taxes fairer and are carefully designed and delivered. One way to achieve this to tax consumption directly. Our research shows that a properly designed progressive consumption tax can help to reduce inequality without a loss of overall tax revenue. A PCT can lead to greater fairness by helping lower-income households to smooth their consumption and have economic incentives to increase their savings. Such a policy should be considered by government both in Westminster and in the three devolved nations”.
Karen Barker, Head of Policy and Research of the abrdn Financial Fairness Trust, said
“This fascinating research adds to the debate on how to ensure fairness in the tax system. It provides a fresh perspective on how the UK’s tax system could be reformed in the longer term. Taxing consumption rather than income could make it easier for people with lower earnings to save, encouraging more households to build up a buffer to protect against income shocks”.
