§ I come now to a major reform in the structure of personal direct taxation. Few people would deny that our existing system is too cumbersome, too complex, and in many respects absurd. We have two taxes on personal income—ordinary income tax and surtax. Each of these is subject to separate and often different rules. They are computed and collected separately and at different times. There is no sense in this division—it is simply an historical anomaly.
§ And there are other absurdities in the system, too. Many of them arise from the fact that the system of personal taxation is structured in terms of investment income, with a complicated pattern of allowances for earned income, despite the fact that earned income constitutes almost 95 per cent. of the total income brought under charge. This causes considerable misunderstanding of the real value of allowances, of the level of tax thresholds, and of the real marginal rates of tax. Many people think that their marginal rate of tax is much higher than it actually is because they confuse it with the standard rate.
§ What we need, therefore, is to replace the existing income tax and surtax, as we now know them, with a single graduated personal tax. Hitherto, such a major 1387 upheaval has always been regarded as well nigh impossible.
§ Nevertheless, I am convinced that, despite the difficulties, nothing but a root and branch reform will meet the need for a more sensible and intelligible system of personal direct taxation.
§ I propose, therefore, to replace the existing income tax and surtax with a single graduated personal tax with the following four principal features.
§ First, the existing pattern of personal allowances will be substantially retained although, as I shall explain, the amounts require adjustment to ensure that they will approximately retain their equivalent value.
§ Second, the tax structure will be founded on a basic rate covering a broad band of income and corresponding to the standard rate less earned income relief.
§ Third, there will be higher rates above the basic rate applicable to the higher incomes.
§ Fourth, while it will still be necessary to retain the distinction between earned and investment income, this distinction will be made by way of a surcharge on investment income in place of the present earned income relief. But it will be an essential feature of the new system that this surcharge will only apply above a certain level of investment income, so that the first slice of such income will be taxed at the rate applicable to earned income. I regard the discrimination against investment income in its present form as a serious discouragement to saving and I am sure that this must be changed.
§ This, then, is the essential structure, and I must now explain how it is to be achieved. The process will involve a good deal of detailed legislation. This will be in this year's Finance Bill. The Inland Revenue will then be able to proceed with all the administrative planning required for this major change. A complete P.A.Y.E. recording will be required and this will be done during 1972–73. The new system will come into full operation from 6th April, 1973. It cannot be done earlier for reasons which I shall make clear in a moment.
§ The provisions of this year's Finance Bill to give effect to these reforms will inevitably be quite complex; and for the 1388 benefit of the House and of the public and the professions, I am arranging for an explanatory White Paper to be published with the Bill.
§ It is obviously desirable that the change-over to the new system should be achieved in such a way that the yield of personal direct taxation over the period of change-over can be maintained, or adjusted as the case may be, to meet short-term requirements. For the purposes of this year's Finance Bill provisions, the basic rate under the new structure will be put provisionally at 30 per cent., but of course this will not commit us to that rate in 1973–74. A final decision on that point must be taken in the light of the circumstances at that time in exactly the same way as in any other year.
§ The Bill will also make provision for the higher rates of tax and the surcharge on investment income. But here again, the actual rates and the starting point for the surcharge, all effective from April 1973, will be fixed in the Budget of that year. Finally, the Bill will fix, provisionally, the personal allowances so that they will approximately retain their equivalent value in the new system. Because the new system will be expressed in terms of earned income, it follows that the amounts of the allowances must be adjusted to take account of the present two-ninths earned income relief. The actual figures will appear in the Finance Bill, but the purpose of these adjustments, as I have made clear, will simply be to ensure that they retain their equivalent values in the new system.
§ The new system, when it comes into force, will involve substantial changes in administration. From 1973–74 deductions under P.A.Y.E. will extend to the full graduated scale of rates, and these will also be applied to assessments on business profits. Income tax will be deducted from dividends and interest at the basic rate, provisionally fixed at 30 per cent., and the higher rates of tax and any surcharge payable will be assessed separately. Because surtax will cease to apply after the year 1972–73, the work of the Surtax Office will come to an end in due course and the change will therefore lead to a substantial saving in staff.
§ The change-over will, of course, in no sense involve double taxation but, 1389 because we shall be moving to a new system of current payments at both the basic and the higher rates on the graduated scale, it will mean that in the one year 1973–74 some taxpayers will be paying this tax on their current earnings, and also surtax in respect of their earnings for the previous year. Those affected have more than two and a half years' notice but, even so, I realise that there may he difficulties for some and, to help them further, payment of part of any substantial sums of surtax for 1972–73 on earnings will be allowed to be deferred for one year.
§ It is desirable not only that we should legislate for the change-over now, but also that we should, where possible, move closer to the sort of pattern which I hope we shall be able to establish in 1973. My decision last October to reduce the standard rate was the start of this process; it brought the standard rate down to 38¾ per cent. and made the effective rate on earned income, after taking account of the two-ninths earned income relief, approximately 30 per cent. I now have two further proposals to make, both of which are highly desirable in themselves and in line with the immediate need, which I have already explained to the House, to give some additional stimulus to the economy this year.
§ First, I believe it is accepted on all sides of the House that there is an urgent need to take action to help families with children. The child allowances have remained unchanged since 1963. It is generally agreed that the tax threshold for families with children is unduly low. I have therefore decided that the great bulk of the personal tax remissions this year should go to taxpayers with children. I propose to increase all the child allowances by £40.
§ The benefit to the family man will be substantial. For instance, for the family with two children the tax threshold will be raised by about £103 a year or nearly £2 a week and the tax—where there is full liability—will be reduced by £31 a year. Or consider another example, where the father is earning £28 a week, which was the average for adult male manual workers shown by the latest Department of Employment inquiry for October. In this case, the father with two young children will, in addition, save £13 a year as a result of the reduction 1390 in the standard rate, making a total cut in his tax bill of £44 a year. The comparable tax reduction for a three-child family is over £58 a year. The House will agree that these are worth-while reliefs for families where help is most needed.
§ I hope and expect that the new P.A.Y.E. code numbers will be issued in time for people to benefit in their pay packets at latest by the first pay day after 5th July. The major recoding operation necessary for this change is one of the main reasons why unification of income tax and surtax cannot start sooner; but I took the view that this tax reduction for families should have priority. Further details of the effects of the reduction in the standard rate and of the increase in child allowances will be found in the Financial Statement and Budget Report.
§ Although there will be no change in the rates of surtax for the year 1970–71, my second priority, in the field of personal taxation, is the need to rationalise the present absurd marginal rates on large earned incomes. In the coming year, the new rate of income tax on earned incomes—effectively 30.14 per cent.—applies to all earned income up to £4,005 a year. Above that level the marginal rate of tax increases rapidly and erratically, partly because of a reduction in the earned income relief to one-ninth and its disappearance above £9,945 a year, and partly because on earned incomes above about £5,500 a year surtax begins to be payable as well as income tax. The combined effect is to produce a steeply rising graduation reaching a top rate of 88¾ per cent. on earned incomes exceeding about £18,500 a year. It would have been 91¼ per cent. but for the cut in the standard rate which I announced last autumn. I regard such a top rate as confiscatory. It has no parallel in any western community; it serves no fiscal purpose, no social purpose, no economic purpose.
§ The top rate of tax on earned incomes which I have in mind for the new system is 75 per cent. reached at a level of about £20,000 a year. This objective can, for all practical purposes, be achieved straight away by increasing the earned income relief above £4,005 a year from one-ninth to 15 per cent. and at the same time abolishing the upper limit. This will give 1391 a top rate on earned income of 75.4 per cent. reached at about £20,500 a year. It also produces a smoother and better graduation over the full range of income above the band at present effectively charged at 30.14 per cent.
§ This change, like the improvement in the child allowances, will take effect for 1971–72. When the new system comes into force in 1973, the new unified scale of higher rates will replace the scale which I have just described.
§ The cost of the improvements in the child allowances will be £163 million in 1971–72 and £207 million for the full year. The cost of the relief for the higher earned incomes will be £16 million in 1971–72 and £38 million for the full year, divided roughly equally between income tax and surtax.
§ Income tax has been with us on and off since 1799. Surtax was introduced, as super-tax, in 1909. Sir Winston Churchill took the first steps to amalgamate the income tax and the supertax in 1928. It is high time we finished the job, and my proposals will do just that.
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