Taxing Families Fairly

The UK’s taxation system is based on an assessment of individual income. This is not unique in the Western world, but there are many countries in which a different approach is taken. At first sight, it may seem reasonable to tax individuals on the basis of their personal income. However, to do so, when we have a system of progressive taxes, leads to highly problematic outcomes. It is also an approach that we believe is flawed philosophically. Miriam Cates MP and, more recently, both Liz Truss and Penny Mordaunt during the Conservative leadership contest, have highlighted the problems caused by our current treatment of families in the tax system and have made the case for reform. Of course, the tax system works perfectly well for single people and our proposals in this paper would not affect them directly. However, for much of our lives, most people do not live as single persons. They live in families or households. When they do, in almost all cases, they share resources with others in the household. Indeed, this is why we measure inequality, both domestically and internationally, by looking at household incomes. It would not make sense to suggest that somebody was poor because they earned the minimum wage for ten hours a week (or earned nothing at all) whilst their spouse was paid £4m a year as a professional footballer. And yet, when we assess them for income tax, that is precisely what we assume. It could be argued that this approach to taxation both pre-supposes and encourages a hyper-individualistic mentality. For fiscal purposes, we ignore the basic unit from which societies are built. This is a cultural and political problem which among other things leaves the UK with a bigger fertility gap (the gap between the number of children people say they want and the number they actually have) than most comparable countries. However, there is also an economic problem. As we show below, this approach to taxation creates huge disparities between the taxation position of families that have the same income depending on whether or not their income is split evenly between members of the household. A single-earner family with a gross household income of £30,000 per annum, for example, pays far more tax than a family where two adults earn £15,000 each. This is inequitable and it creates perverse incentives for members of the household to take employment decisions based on their tax position rather than on their domestic circumstances. The system directly discriminates against households where one member takes on caring responsibilities for younger or older members of the family. Interestingly, our welfare system tops up incomes based on an assessment of household income. The spouse of the footballer mentioned above does not receive welfare benefits simply because they have low earnings because eligibility takes into account the earnings of both spouses or both members of an unmarried couple. When we put the tax and welfare systems together, we find that family formation is penalised – to a substantial degree. If, for example, a woman has a child and does not work whilst the father is in paid employment, if they live together or marry, her entitlement to benefits is lost whilst he continues to pay tax at the same rate as if they were single. They are, literally, better off apart. Thus, the state, through having designed an individualised tax system alongside a benefits system based on household income penalises the family as if, somehow, it is a bad thing that needs to be discouraged through taxation. Of course, all the evidence suggests the opposite. The family is important for individual wellbeing as well as having beneficial societal effects. These questions might only be of theoretical interest if it were impossible to envisage things being done a different way. However, as we show, many countries levy taxation based on household and not individual income. Such countries include France and Germany. In the chapters immediately following we discuss the economic and philosophical arguments for our current approach to taxation as compared with alternatives. We then follow this by modelling the cost to families with an uneven split of earnings between their main adults of the current tax system. After examining the relationship between the tax and benefits system, we examine how we can “tax families fairly” by moving to an approach along the lines of that used in France and Germany. We conclude that it is important for the UK to adopt an approach that involves taxing families on the basis of their family income and structure rather than taxation being based on the assumption that we live as individuals outside families and households.