A new deal for the young: mending the tax system

In a series of articles this week, the Financial Times has highlighted how the economic system disadvantages the young, and proposed measures to right the balance. No such programme is complete without taking a hard look at taxation.

It is a key function of the tax system to smooth incomes over the course of our lives, taking from those in their prime working years to spend on children, the young and the elderly. Today’s young, however, face the burden of supporting other cohorts in mid-life while benefiting much less at the start or end of their working lives.

Before today’s under-40s arrived on the scene, their elders — especially baby boomers — had accumulated assets from a past era of record productivity growth and a windfall from the secular fall in interest rates. In four decades, private wealth, disproportionately held by older cohorts, has doubled in proportion to national income. The wage growth they enjoyed when young has become elusive.

Yet the relative tax pressures on wealth and income, on the old and the young, have not followed suit. Indeed today’s young are set to pay much more in taxes, or be much worse provided for in old age, than older generations — most likely both.

Taxes and benefits should counter, not reinforce, the ways economic demography stacks the deck against the young. That means designing tax to maximise their opportunities for prosperity and alleviate their responsibility for the well catered-for cohorts above them. How to do this varies by country, but some general principles apply.

FT series: A New Deal for the Young

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Monday Housing affordability is a problem in many countries. How can we fix the crisis?

Tuesday How to secure a decent pension for today’s younger generation. A third way is needed.

Wednesday Building better jobs: like every generation before them, young people desire decent, secure employment with prospects.

Thursday A rethink on education: who should pay for university education, and what about those who don’t go?

Friday Young people face a future of environmental destruction. What can be done to fix it?

Saturday Taxing fairly: today’s young face the burden of supporting older generations but benefit much less at the start and end of their working lives.

First, equivalent incomes should be taxed at similar rates at all ages, or even skewed in the young’s favour. Often the opposite is the case since the composition of income changes with age. Tax rates on wage and capital earnings, and on income from employment and self-employment, should be brought closer together. Separate income and payroll taxes could be merged to make them more smoothly progressive.

Above all, abolish any outright favouritism of older people’s incomes, such as the UK’s exemption from national insurance for those past the state pension age. Consider the opposite instead: special low tax rates for, say, the under-25s, to improve work, earnings and savings prospects. Many countries already have lower wage floors for the young. An alternative would be generous refundable tax credits at early working age, allowing everyone to accumulate assets by mimicking a capital endowment.

Second, the taxation of wealth must be revisited. The growing importance of wealth makes opportunities more unequal among the young, as inheritances matter more. Even young people who stand to inherit find their prospects depend more on the older generations, as the inheritance rarely arrives until they reach their 50s or 60s. To maximise opportunities for the young and their generational independence there is no way around wealth shouldering more of the burden of taxation.

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One option is to roll inheritance tax into a lifetime gift tax with a reasonable lifetime tax-free allowance but more strongly progressive rates above that. Some countries, including Norway and Switzerland, have chosen another route: they limit or eliminate inheritance and gift taxes but levy an annual net wealth tax. This might encourage the elderly wealthy to pass on their wealth sooner. OECD research suggests, however, that wealth taxes can be counter-productive, discouraging innovation and entrepreneurship.

Given how hard it can be to buy one’s first house, more progressive property taxation is especially urgent, plus measures to make housing more plentiful and affordable. More generally, the total tax burden on capital could rise to make room for lower taxes on labour, so long as it is compatible with strong incentives to save early in life.

Third, where student financing interacts with the tax system, the state should visibly take a risk investment in students. Whatever tax and subsidy treatment is given to education at school-leaving age should also apply to lifetime learning.

Generational injustice has many roots, but current tax structures make things worse. The politics of tax also favours the elderly who vote more. It is time for young voters to make their voice heard — and for the rest of society to listen.

Other editorials and pieces in this series can be found at ft.com/newdeal