Making allowances – 12 conclusions about the Personal Allowance policy (libdemvoice.org)

CentreForum today published ‘Making allowances’ – a paper all about the Lib Dems’ flagship policy of raising the income tax Personal Allowance. Here are some of my conclusions – some obvious, some more obscure – to help inform future tax cuts.

1) The costs are huge. The coalition’s Personal Allowance increases have cost £11bn, and the Lib Dems’ minimum wage tax target would cost at least the same again. With this combined total, we could (roughly) reduce VAT to 15%; scrap council tax or business rates; easily deliver quality universal childcare; or pay for a project like HS2 every year. We need to talk much more about these opportunity costs.

2) Be careful about funding. Which £11bn of spending cuts, borrowing or tax increases funded the higher allowance? The coalition’s rules likely mean that all tax cuts are balanced by tax increases but, still, one could say it was the £13bn VAT increase that funded income tax cuts (a regressive combination). High costs might also interfere with fiscal plans and coalition discussions. Could a LibLab coalition find and deliver over £11bn of tax increases for the new Lib Dem policy as well as more for deficit reduction? Or, if this policy is a ‘red line’ but not the way in which it’s funded, can we guarantee it won’t be funded through welfare cuts or similar?

3) Most of the money doesn’t go to low earners. Allowance increases are much more pro-poor than cutting the basic rate, but over three quarters of the £11bn cost has nonetheless gone to the richer 50% of families. If the main goal is to help near-minimum wage workers and take people out of [one sort of] tax, the policy’s cost is currently almost entirely ‘deadweight’ of helping the better off.

4) Does any of the money go to poorer families? What’s more, under Universal Credit, 65% of any tax cut will be withdrawn from most poorer households. The party should clarify whether it would recycle that money back to these families, or whether extra cash for poorer households is somehow not the point.

5) Have allowance increases limited pay increases, and boosted employment? Tax cuts can be passed between employers and employees, and it may be that propping up disposable incomes with employee tax cuts has allowed employers to increase wages by less. The flipside is that such tax cuts might sometimes mean higher employment through lower employer costs. This is on top of positive effects on work incentives: marginal rates are reduced for some low earners (even with Universal Credit), and the incentive to rejoin or remain in the labour force is boosted.

6) Taking people out of auto enrolment and childcare support. The Personal Allowance is also the threshold for pension auto enrolment and for extra Universal Credit childcare support. The latter condition at least could easily be changed, but for now allowance increases will make some families worse off, and take millions more out of pension saving. Some tax breaks are also currently linked to the allowance.

7) National Insurance (NI) should be the priority. Why campaign for a £12,500 income tax allowance when some NI starts at £5,885? Employee NI alone is more of a burden than income tax for everyone earning under £13,000 (£52,000 if we include employer NI). 1.5 million earners would benefit from a NI cut but not at all from further Personal Allowance increases, with many more getting only a little from the latter. A NI cut of the same cost would be twice as valuable for the poorest 20% of households; while income tax cuts increase the bias towards rent etc. over labour income. Employer NI cuts shouldn’t be excluded either, and might allow for a higher minimum wage. Aligning the NI thresholds with each other and with the £10,000 Personal Allowance would bring real tax simplification benefits too (and NI cuts do not affect benefit eligibility).

8) The tax system is complicated! Surprisingly, if the Personal Allowance is raised to £12,500, those earning £125,000 or more will get a £500 tax increase (even before any changes to the higher rate threshold): an accident caused by the complex withdrawal of the Personal Allowance (a 60p tax band made bigger by allowance increases). Reducing the higher rate threshold is also complicated: while it can cancel out income tax cuts, at the same time it gives a NI cut to most (but not all) higher earners.

9) Increase the basic rate to target tax cuts on low earners. Better than reducing the higher rate threshold would be to increase the basic rate: not leaving anyone worse off but tapering away the tax cut. Higher rate payers would get zero overall, low earners the full amount and other basic rate payers something in between based on their income. If Lib Dems were prepared to increase the basic rate to ~23%, they could for the same cost raise the Personal Allowance to £14,600 instead of £12,338, further helping those earning less than £28,000 – surely the intended targets – by giving richer taxpayers a smaller tax cut. Or, such targeting could be used to reduce the cost. That said, larger rate increases – especially for NI – would be a fair way to entirely fund allowance increases. Even the Tory peer who originally proposed a £10,000 threshold (back in 2001) wanted to fund it through higher rates.

10) It’s a £480 income tax cut, not £705. The Personal Allowance would have risen with inflation even without the Lib Dems. Similarly, the proposed £100 tax cut for 2015-16 would really be only £50-60 (and seems mainly an attempt to avoid a purely inflationary increase – that the party couldn’t take credit for – complicating its message).

11) The minimum wage is not a good formal target. It is not a measure of living standards, nor even an annual figure. We have already taken the majority of minimum wage workers – most of whom are part-time – out of income tax: it’s fairly arbitrary whether an annual equivalent should be 35, 37.5 or 40 hours per week rather than the current 30 (plus, income tax is only one of many taxes). Another challenge is that the tax year is from April while the NMW changes in October. It’s also odd that we might adopt the NMW as a link just as it is judged to be in need of reform. While it’s fallen in real terms recently (which would have meant a tax increase under an allowance link) it will likely increase in coming years (if it stays in its current form) further increasing the cost. But would ministers still accept – let alone push for – a higher NMW if every 10p increase meant finding another £1bn for our tax cut? In short, I don’t see how an hourly, expert-recommended wage, limited to avoid unemployment, could remain linked to an annual, political, tax level: they are both too important.

12) We could take the poverty line out of tax. My report considers links to the Living Wage and median incomes, but concludes that the poverty line is the most compelling at present. This differs between family types but one could say, given our individual-based tax system, that childless adults should not be pushed below the poverty line by direct taxation. The relative poverty line has been taken out of income tax – but not NI – thanks to coalition policy. The absolute poverty line for a single adult is £10,050 in 2014-15 (and ~£10,350 the year after). Clegg’s small “worker’s bonus” (plus relinking to RPI) could take this out of income tax, but a large NI bill would remain.

All in all, there are good reasons to be sceptical of any allowance increases – on all sides of the party. It may be unhealthy to let it dominate a decade or more of the party’s policy development, budget commitments (as it has and will) or message (“vote for us and we’ll give you £500”).

But there are also ways in which the policy can be improved. Choose National Insurance; do more to target the low paid; and take care with funding, interactions with other policies, and the choice of target. Read the full report for more.

Originally published at http://www.libdemvoice.org/opinion-making-allowances-12-conclusions-about-the-personal-allowance-policy-37854.html

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