The Flat Tax Revolution

Written By Kosala Ubayasekara

The Macroeconomic Case for a 15% Flat Tax and Consumption-Based Revenue Model in the United Kingdom

The fiscal landscape of the United Kingdom stands at a pivotal juncture, characterized by a tax-to-GDP ratio that has reached its highest level since the post-war era. In the 2024/25 financial year, public sector current receipts are estimated to reach £1,139 billion, or approximately 39.4% of national income. This burden is largely supported by a progressive personal income tax system that, while designed for equity, has increasingly become a source of economic distortion, administrative complexity, and fiscal drag. As the government seeks to foster long-term productivity and growth, the proposal to replace the current multi-tiered progressive structure with a uniform 15% flat tax—complemented by a broadened value-added tax (VAT) base—presents a transformative pathway. This transition is predicated on the theoretical and empirical evidence that lower marginal rates, combined with a shift from taxing production and investment toward taxing consumption, can successfully sustain the exchequer through enhanced compliance, increased labor supply, and a dynamic expansion of the economic base.  

The Structural Fragility of the Progressive Status Quo

The current UK tax regime relies heavily on three primary pillars: income tax, National Insurance Contributions (NICs), and VAT, which together accounted for approximately £651 billion in receipts for the 2024/25 period. Income tax alone contributes £306 billion, yet its collection is highly concentrated among a small fraction of the population. Approximately 60% of total income tax revenue is derived from the top 10% of earners, with the top 1% providing 30% of the total. This reliance on a narrow demographic creates significant revenue volatility and subjects the fiscal envelope to the behavioral responses of the most mobile and tax-sensitive individuals in the economy.  

The phenomenon of fiscal drag has further exacerbated the inefficiencies of the progressive model. By freezing the personal allowance at £12,570 and the higher rate threshold at £50,270 during a period of high nominal wage growth, the government has effectively "stealthily" increased the tax burden. Projections for 2024/25 indicate that the total number of income taxpayers will rise to 37.4 million, with 6.31 million individuals now caught in the higher rate (40%) band and 1.13 million in the additional rate (45%) band. This bracket creep not only reduces household disposable income but also creates "cliff edges," such as the withdrawal of the personal allowance between £100,000 and £125,140, where the effective marginal tax rate can reach 60%, significantly dampening the incentive for high-productivity individuals to increase their output.  

Table 1: Comparative Evolution of UK Taxpayer Populations

The data suggests that the progressive system is reaching a point of diminishing returns. The elasticity of taxable income for additional rate payers is a critical variable in this context. While HM Revenue and Customs (HMRC) previously estimated this elasticity at 0.48, more recent analysis suggests that it may be as high as 0.83 for the highest earners when accounting for pension forestalling and other tax planning measures. High elasticities indicate that a substantial portion of the revenue theoretically gained from higher rates is lost to behavioral changes, including reduced hours, offshore income shifting, or increased use of exemptions.  

Theoretical Foundations of the 15% Flat Tax Model

The proposal for a 15% flat tax is not merely a reduction in the headline rate but a fundamental shift toward a "comprehensive income tax" that treats all forms of income equally. In this model, the distinction between earned income (wages) and unearned income (dividends and capital gains) is removed, thereby eliminating the incentive for tax arbitrage. The theoretical justification for such a reform is rooted in the "supply-side" effect, where a reduction in the marginal tax rate (MTR) increases the after-tax return on labor and investment, leading to an expansion of the capital stock and labor hours.  

A revenue-neutral flat tax, when calibrated appropriately, has been modeled to increase annual per capita growth by between 0.18 and 0.85 percentage points. In the UK context, such a shift could produce a "level shift" in GDP of up to 24% over a thirty-year horizon, equivalent to an 0.8% increase in the annual growth rate. This growth is driven by the removal of the deadweight loss associated with complex progressive schedules. For smaller companies in the UK, the social cost of the current corporation tax regime is estimated to be as high as 29% of the revenue collected, meaning that for every £100 raised, society loses an additional £29 in wasted economic potential.  

The Solow Residual and Dynamic Scoring

To model the success of this transition over time, one must utilize dynamic scoring, which accounts for the secondary effects of policy changes on the wider economy. Static scoring, often used by official bodies, typically assumes that economic output remains constant. In contrast, dynamic scoring incorporates the "feedback" from higher investment and consumption. For example, a reduction in the rate of personal taxation for high-income individuals often leads to large behavioral responses; the decision to cut the top rate from 50p to 45p was initially costed as a £3.8 billion loss, but once behavioral responses were included, the estimated loss was reduced to just £100 million.  

The 15% model operates on the assumption that R=τ(Y−A), where R is revenue, τ is the 15% flat rate, Y is total income, and A is a high personal allowance. By lowering τ to 15%, the government significantly reduces the marginal disincentive to earn the "next pound." While this might initially suggest a revenue shortfall, the expansion of Y through increased labor participation and reduced evasion—as seen in the Russian experience where real personal income tax (PIT) revenues rose by 26% after cutting the top rate to 13%—offsets the lower rate.  

Consumption as a Fiscal Stabilizer: The Role of VAT

The central thesis of the proposed reform is that the shortfall from lower personal income taxes can be recovered through a broadened VAT base. Currently, VAT is the UK’s second-largest source of revenue, expected to raise £180.4 billion in 2025/26. However, the system is hampered by a complex array of exemptions, zero-rates, and a high registration threshold of £90,000, which is the third-highest in the OECD. This high threshold distorts markets by discouraging small businesses from growing beyond the registration limit to avoid the 20% "tax cliff".  

Broadening the Base and Scrapping Exemptions

The UK's VAT currently covers less than half of the potential consumption base. By eliminating zero-ratings and reduced rates (5%) on items such as food, energy, and children's clothing, the exchequer could raise an additional £24 billion or more annually. A simplified system with a lower, uniform rate (e.g., 12.5% or 15%) applied to all goods and services would be less distortive and easier to administer.  

Table 2: UK VAT Revenue and Expenditure Distribution (2024-25)

The transition to a consumption-based model leverages the Marginal Propensity to Consume (MPC). When personal income taxes are cut, particularly for lower-income quintiles who are often "hand-to-mouth," a high proportion of that disposable income is immediately returned to the economy through spending. While mean MPCs in the UK can be low (around 0.11) during periods of uncertainty, direct elicitation for liquidity-constrained households shows MPCs as high as 0.51 to 0.79. Shifting the tax burden to consumption ensures that those who choose to spend their income contribute to the exchequer, while those who choose to save and invest are rewarded with a lower immediate tax burden, thereby fueling long-term capital formation.  

International Case Studies: Empirical Evidence of Flat Tax Success

The feasibility of a 15% flat tax is supported by the experiences of transition economies in Central and Eastern Europe. These countries utilized flat taxes to simplify their administrations and attract foreign investment.  

The Russian "Tax Miracle" (2001)

In 2001, Russia replaced a progressive system with a top rate of 30% with a single 13% flat rate. The result was a 26% real increase in PIT revenue in the subsequent year. Critically, analysis shows that this was not primarily a supply-side response in terms of hours worked, but rather a massive improvement in compliance. The 13% rate was low enough that the cost of evasion exceeded the cost of compliance, leading to the "formalization" of previously hidden "envelope wages".  

The Slovakian Unification (2004)

Slovakia introduced a 19% flat tax in 2004, applying it uniformly to personal income, corporate income, and VAT. This reform simplified a system with 90 exceptions and 21 different rates. While revenue as a share of GDP initially fell by 0.7%, the reform was associated with a period of rapid growth and improved labor market incentives. The elimination of progressive brackets removed the disincentive to "earn more," while the shift to indirect taxes allowed for a more attractive investment environment.  

The Estonian Model of Neutrality

Estonia has maintained a flat tax system since 2000, ranking 1st on the International Tax Competitiveness Index for over a decade. The Estonian system only taxes corporate profits when they are distributed, encouraging companies to reinvest. This model relies heavily on VAT, with income taxes making up a relatively small share of total revenue. This highlights that a 15% flat tax in the UK could be part of a broader strategy to become the most competitive environment for business in the G7.  

Administrative Efficiency and the Small Business Tax Gap

A significant portion of the UK's uncollected revenue—the "tax gap"—is attributed to the complexity of the current system. In 2023/24, the tax gap was estimated at £46.8 billion, with 60% of this total stemming from small businesses. Small businesses (turnover <£10m) currently fail to pay roughly one-third of the corporation tax they owe.  

Reducing Compliance Costs

A 15% flat tax would dramatically reduce the administrative burden on these firms. Currently, small business owners must navigate complex rules for dividends, capital gains, and NICs to minimize their liability. A flat tax on all business cash flows and personal income would eliminate these incentives for misreporting. Economists have estimated that a flat tax could reduce compliance costs by up to 90%, allowing businesses to focus on productivity rather than tax planning. If the small business tax gap were narrowed to match the performance seen in large businesses through such simplification, the exchequer would collect an additional £15 billion annually.  

Table 3: UK Tax Gap Components (2023-24 Estimates)

  The high corporation tax gap (15.8%) specifically points to the distortions created by the recent increase in the corporate rate to 25%. A 15% flat rate for both individuals and companies would create a "neutral" environment where capital is allocated based on economic merit rather than tax efficiency.  

Distributional Analysis: Impact Across Income Deciles

The primary political hurdle for a flat tax is the perception of regressivity. However, a 15% flat tax combined with a significant personal allowance (e.g., £10,000 to £12,000) can actually be more progressive at the lower end than the current system. Modeling by the Institute of Economic Affairs suggests that if the reform includes the abolition of NICs and council tax, the poorest decile would see a 26% increase in their gross income.  

Table 4: Estimated Impact of a 15% Flat Tax Reform Package on Gross Income

This "U-shaped" benefit occurs because the poorest currently pay a disproportionate amount in indirect taxes and NICs relative to their income. By removing these regressive elements and replacing them with a high-allowance flat tax, the "participation tax rate" (the tax paid when moving from benefits to work) is significantly lowered, encouraging labor market entry.  

The "Prosperity Package" for High-Net-Worth Individuals

To mitigate the risk of a "wealth exodus" from the top decile, the model can include a "Prosperity Package" for non-domiciled and high-net-worth individuals. By requiring an upfront investment of £3 million in strategic sectors and an annual £300,000 fee for a 15-year exemption from global inheritance and foreign income taxes, the UK can attract mobile capital. This package is estimated to generate £12.9 billion in cumulative tax revenue over 10 years while raising the invested capital stock by nearly £6 billion.  

Dynamic Transition and Financial Sustainability

The successful implementation of a 15% flat tax over time depends on the transition from an income-based model to a consumption-based one. The revenue shortfall from cutting income tax must be bridged by the expansion of the VAT base.

Phased Implementation and the "J-Curve" Effect

Fiscal policy often experiences a "J-curve" effect, where revenues fall in the immediate aftermath of a tax cut before the pro-growth effects take hold. To manage this, the reform can be phased over a five-to-ten-year period. In the initial phase, the VAT registration threshold can be lowered—currently £90,000—to bring more economic activity into the tax net, while simultaneously broadening the base to include previously zero-rated items.  

The Mathematical Sustainability of the 15% Rate

The financial sustainability of the 15% rate is predicated on the growth multiplier. If a 10 percentage point reduction in the tax-to-GDP ratio produces a 0.8% annual growth dividend, the total size of the UK economy would be significantly larger by year ten.  

GDPt​=GDP0​⋅(1+g+Δg)t

Where Δg is the growth dividend from the flat tax reform. As the denominator (GDP) grows, even a lower tax rate (τ=0.15) can produce a higher nominal revenue yield. Furthermore, by abolishing taxes on "good things" like work and saving, the system incentivizes future consumption over short-termism. Taxes on capital income (interest, dividends, and corporate profits) effectively tax future consumption higher than current consumption; removing these biases can boost long-run GDP by an additional 7%.  

Long-Term Outlook: A Fiscally Responsible Alternative

The UK's public finances are currently in a "perilous" position, with net debt exceeding 90% of GDP. The Adam Smith Institute’s Fiscal Sustainability Model reveals that without radical supply-side reforms, the government's solvency will remain under pressure. A 15% flat tax serves as the "radical reform" needed to unlock productivity.  

Labor Mobility and Housing Reform

The 15% model should also include the abolition of Stamp Duty, which currently punishes labor mobility and locks homeowners into unsuitable properties. Replacing Stamp Duty with a land value tax or a housing consumption tax (set at 12.5%) would create a more fluid housing market, allowing workers to move to high-productivity areas, thereby indirectly boosting income tax and VAT receipts.  

Final Synthesis: The Mechanism of Success

The financial model proves that a 15% flat tax is not merely a tax cut but a tax reform. The revenue is replaced not through higher rates on the few, but through a broader contribution from the many, facilitated by the elimination of exemptions that currently hide half of the UK's consumption from the tax man. By Year 10 of the model, the UK economy would be characterized by:  

  1. Increased Compliance: A narrowing of the £46.8bn tax gap as the 15% rate becomes the global benchmark for ease of doing business.  

  2. Higher Labor Supply: The removal of "cliff edges" and the 60% effective marginal rates, encouraging millions to work more hours or seek higher-paying roles.  

  3. Consumption-Driven Stability: A robust VAT stream that captures the economic activity generated by a 24% "level shift" in GDP growth.  

This transition ensures that the UK can maintain a welfare state of significant size—as seen in countries like Australia and Switzerland which spend less than the UK as a share of GDP—while fostering a dynamic, high-growth environment. The 15% flat tax is the essential mechanism for aligning the UK's fiscal policy with the realities of a mobile, globalized 21st-century economy, ensuring prosperity for all deciles through a simpler, fairer, and more efficient tax code.  


Kosala Ubayasekara