Saturday 13 March 2010

Why the LibDem tax threshold plan would increase inequality

Saturday's Guardian interviews Nick Clegg, who has had a high media profile this week, and who enjoyed the boost of celebrating the defection of Edward McMillan-Scott MEP from the Conservatives on Friday.

The Liberal Democrat leader sounds naturally keen to defend his flagship policy of increasing the income tax threshold to £10,000, as The Guardian reports in asking him to respond to a Fabian and Left Foot Forward analysis of its distributional impact.

But are they chimeric and difficult to pin down, with different slants put on policies for different political audiences? In an interview with the Spectator Clegg says their tax allowance rise is something Nigel Lawson could be proud of, while in this interview he spent 13 minutes arguing vociferously against research by the Fabian society that shows this policy to be regressive.

We have not yet heard what his vociferous objection to the research finding might be. But that his flagship policy would have regressive distributional effects would appear to be a matter of fact, rather than political opinion.

That is the conclusion of this first detailed modelling and factual analysis of its distributional consequences, published on Saturday by Left Foot Forward and available to download from the site. The report is co-authored by Fabian Research Director Tim Horton and Howard Reed, an economics consultant at Landman Economics and tax modelling specialist who was previously chief economist at ippr after a decade at the Institute of Fiscal Studies.

Key findings include:

* Only £1 billion (6%) of the approximately £17 billion cost is spent on removing low earners from paying any tax at all.

* Three million of the poorest households gain nothing from the change.

* Households in the second richest decile gain, on average, four times the amount of those in the poorest decile.

* Overall, around 70 per cent of the cost of the policy goes to those in the richer half of society, and 30 per cent in the bottom.

The report shows that the impact of the policy will therefore be to increase inequality between the middle and the bottom of the income distribution, relative poverty and the 90-10 inequality measure between those 10% from the top and 10% from the bottom.

Some other good measures being proposed by the Liberal Democrats would tax those in the top decile more: these merit support. But these do not depend on spending £17 billion on the tax threshold change. Other uses of these resources money could have a progressive, rather than regressive distributional impact. (Alternative proposals from right-wing commentators which would raise thresholds "to lift the poor out of tax", funding this through reduced public spending would be more regressive than the LibDem proposal, given the highly pro-equality redistributive impact of public spending).


That lifting the tax threshold has a regressive distributional impact may seem counter-intuitive to some.

One reason the gains accrue disproportionately to the top half of the income distribution is that the biggest gainers from the tax change will be those double-income households with two full-time workers, who both can benefit fully from the raised threshold.

Single-earner households where one partner has caring responsibilities and works only a few hours or not at all won't gain as much.

Those earning under £10,000 gain less than higher earners: a quarter of the four million part-time jobs done by women pay less than £5,400 a year and half under £8,0000.


The LibDem tax threshold policy has many advocates on the right of British politics, including Norman Tebbit and Guido Fawkes.

Indeed, similar plans were promoted by Lord Saatchi in the Conservative Party ahead of the 2005 election. Michael Howard explained in his post-election lecture to the Centre for Policy Studies why he had changed his mind about Maurice Saatchi's pitch to take the poor out of tax by increasing personal allowances:

So initially I was extremely attracted to an increase in personal allowances for income tax and the NIC earnings threshold, along with a rise in the basic rate limit to help those higher up the scale ... until we looked at the practicalities of it.

A tax cut along these lines - costing nearly £3bn - would have given the poorest 10 per cent an average change in net weekly income of precisely 7 pence.

Even the fourth poorest decile would have received less than £1 extra - equivalent to 0.34 per cent of their income.

In contrast, the richest decile would have received nearly £7 more a week.

That is why we looked elsewhere.

Howard was drawing on a detailed analysis from David Willetts challenging Saatchi's plan by arguing that "raising the personal tax allowance costs an awful lot of money because it helps almost everyone. And it is worth least to people on low incomes who don’t get the full value of the policy".

Willetts also challenged a cherished right-wing myth about tax credits.

Some people believe this is still worth doing because it would get people off Gordon Brown’s tax credits. It is assumed that people on modest earnings are paying as much in income tax as they are receiving in tax credits. If this were true, I would leap at the opportunity to tackle this problem ..

But the amount of money that a low-income family is receiving in tax credits is much greater than the amount they are paying in income tax.

If you are earning £10,000 a year you might be paying £900 a year in income tax but receiving, depending on your family circumstances, several thousand pounds in tax credits. No affordable increase in the personal tax allowance will offset most low-income families’ tax credit entitlements.

Despite these sound pieces of tax analysis five years ago, the Conservative Party in 2010 is promoting a regressive tax break for married couples, as well as its inheritance tax cut at the top.


So what might a progressive approach to cutting taxes look like? The Fabian Society Solidarity Society report proposed the introduction of a flat-rate universal tax credit. This would make it possible to reduce taxes for all by the same amount - meaning lower earners see their incomes rise by a higher percentage - whereas changes to thresholds will always have regressive features by definition.

That is a longer-term debate.

For now, the political and policy debate about the merits of the LibDem proposal will continue.

It could well prove politically attractive, because it will benefit middle and upper income earners who are likely to play a key role in Liberal Democrat-Conservative marginals.

And the policy has also been praised as progressive and redistributionist by liberal-left voices. Earlier this week, John Kampfner argued his preference for the Liberal Democrats over Labour not only over civil liberties or foreign policy but because

Their tax reform plans, taking 4 million low-paid workers out of tax altogether, are the most redistributive of any party.

In fact, the distributional impact of the LibDem proposal contrasts sharply to the tax and benefit changes pursued by Labour since 1997, which have had strongly progressive pro-equality effects. (See page 27 of the Left Foot Forward report for the comparison).


Stuart White said...

This is a much-needed analysis of the tax threshold proposal. I do hope that you'll be sending a copy to John Kampfner.

The Lib Dems do have areas of progressive advantage over Labour - notably on civil liberties. But on the basics of tax and spend, they have persistently made non-progressive choices - tax cuts that disproportionately benefit the rich; scrapping the Child Trust Fund; phasing out tuition fees.

Robert said...

We know Browns tax regime, tax the poor more give it to the beloved middle England voter.

No wonder so many of us are leaving the party

_______ said...

The lib dems should read the solidarity society, and implement a universal flat rate benefit for all citizens in employment/self-employment.

Unknown said...

Clegg's idea is only 50% of the solution. The other 50% would be to raise the taxation level for those earning from £10000 to £50000 so that these people are net no better or worse off, so you effectively ONLY benefit those earning less than £10000. Its not rocket science but the Fabian Society conveniently fail to do the tiniest bit of thinking as it has the potential to drive people off benefits and into work, something the Labour movement doesn't want as it likes to maintain a client state.

This government wastes billions in administering their tax credit system, just abolishing it altogether could raise the personal allowance to close to the £10k mark.

We need to incentivise working in this country and sorry, Labour have not done this in over a decade in power.

Politicians are all too gutless to radically shake up the tx system to get what we the people need out of it.

Incentivise working, incentivise ambition and you will improve peoples quality of life without expecting middle England to pay for all the feckless and lazy!

Guido Fawkes said...

I'd like to see more of the calculations. It goes without saying that of course the middle classes need a tax cut as well.

Just because a policy allegedly increases inequality does not disqualify it. If a hypothetical silver bullet policy raised the income of the bottom decile 100% and the income of the top decile 101%, I wouldn't say that policy failed.

As for raising marginal tax rates on high earners any further it won't work. It is that simple. They will simply either find ways to avoid penal tax rates or leave.

Sunder Katwala said...

There are now several more responses on the Left Foot Forward thread.



re: "I'd like to see more of the calculations".

I don't know if you've read the 30-page paper on Left Foot Forward, but I think we can say that we have somewhat raised the analytical level of policy discourse on the blogosphere today.



I think the main reason that the LibDems do not do that is that they want to offer tax cuts all the way up the income spectrum. This is electorally popular, but not distributionally progressive.



Will send to John Kampfner, and would also of course be happy to carry any response from him here on Next Left.


Rational Thinker


Letters From A Tory said...

I absolutely agree with raising the tax threshold to £10,000 but I also think that eligibility for this threshold needs to be considered. For example, does someone earning £150,000 need to be allowed not to pay tax on the first £10k that they earn? Obviously not.

The whole point of raising the threshold is to help low earners, which is why eligibility should be withdrawn gradually for higher earners at the same time to make sure the policy is a targetted one.