7 October 2010

Alongside the pupil premium, which I discussed in this post the other day, the Libdems cry up their role in the Tory Libdem government’s cutting tax for the low paid, one of the Libdem pre-election flagship policies. The intention is to raise over time the threshold at which income tax begins to be paid to £10 000; in the 2010 Tory Libdem budget a start was made by raising it by £1000 to £7 475pa from April 2011.

That took nearly 900 000 low paid out of income tax, surely an unalloyed progressive move. Hmm. I think it’s not as clear cut as that. Let’s see.

Many of the arguments have been well set out here by Tim Horton and Howard Reed. The Tory Libdem raising of the tax threshold to £10 000 would do nothing to help the seriously poor who pay no tax and most pensioners would gain nothing.

Income tax is a relatively small part of the tax paid by households in the lowest income groups; VAT is much larger proportionate take from them. The Tory Libdem government has increased VAT from next January.

Proportionately, the more affluent households get more from the threshold rise than those on low pay. Raising the threshold to £10 000 would cost about £17 billion. Of that about £1 billion would go to those at the bottom, the rest – about ninety four percent – would go to those on middle and higher incomes. It is this skew to the better-off which leads progressives to wonder whether raising the tax threshold is the most effective way of helping the low-paid. The skew to the better-off, the larger gain for them, also increases relative inequality between the households in the bottom and middle/higher income groups.

Aware of this skew and presumably in a wish to mitigate its immediate effects, in the 2010 budget the higher 40% rate taxpayers were in fact excluded from gaining from the £1000 threshold rise by a lowering of the starting point for the higher tax rate from April 2011. Will this exclusion be temporary ? What will happen if the basic threshold is raised again from 2012; will the higher tax starting point also be lowered again and begin to include in the higher tax band very many more people? It will be interesting to see what happens in the next budget. (The implications for the recent child benefit changes are clear.) In the meantime, for example, someone on £35 000 a year gains more than someone on £9000: what the Libdems call progress and fairness apparently.

Libdems recognised the regressive nature of only raising the tax threshold and presented their pre-election policy as a tax package and revenue neutral; some other taxes would take money from the affluent, measures such as a mansion tax and increased capital gains tax, and would also make up the lost revenue. Thus the better-off should not in the balance gain from the threshold increase of the Libdem package; indeed the package should be redistributive from them. However, that tax switch policy has disappeared (mansion tax) or been watered down (a limited increase in capital gains tax to 28% for higher rate income tax payers).

To sum up: despite Libdem hurrahs, this is scarcely a progressive policy. Reducing the tax paid by the poor by increasing the basic threshold certainly helps those on low incomes and paying tax but does not help those too poor to pay tax. It also very disproportionately helps those on middle incomes: the bulk of the money goes to them, even with the current and probably temporary exclusion of the better-off. It increases inequality between poor and middle income households. The Libdem idea of a tax package has more or less sunk.

A better way of helping the poor would be to increase directed payments to them such as tax credits and benefits and to make work financially worthwhile.

Over the next months the Tory Libdem government will continue to rejig the tax and benefit arrangements and we shall be able to add them up to see which households have gained overall and which have lost.


David Willetts in June 2005.

I previously briefly discussed this threshold question here.