Wednesday 28 April 2010

LibDem tax fairness? The IFS verdict

There was a very spirited and actively contested debate about the merits of the LibDem proposal to raise the income tax threshold to £10,0000, following Left Foot Forward's critique of the tax plan written by Tim Horton, Fabian research director, and tax modelling expert Howard Reed of Landman Economics.

The Left Foot Forward report argued that the £17 billion LibDem plan "failed the fairness test" because 70% of the gains went to the top half of society while leaving the poorest households out. LibDem politicians and bloggers argued that the critique was unfair, because funding the £17 billion tax cut from taxes focused mostly on the wealthiest meant it could be defended as a progressive tax fairness move.

The Institute of Fiscal Studies has now published its detailed analysis of all three major party manifestos, which therefore can be used to assess both sets of arguments.

Its analysis of the income tax cut is very similar to that published by Left Foot Forward.

The IFS verdict on the overall LibDem manifesto is that it seeks to redistribute from the best-off towards middle-incomes rather than to poorer households. The IFS report also suggests that it is misleading to advocate the tax threshold policy as a response to the high proportion of tax paid by the poorest.

The IFS conclusion on the overall LibDem approach is that:

"Broadly speaking, the Liberal Democrat package would redistribute from the well-off to middle-income families – augmenting the progressive pattern of Labour’s pre-announced measures but doing little for the poorest households. This latter feature might appear odd given the Liberal Democrats’ often-expressed anger at the relatively high rate of tax paid on the gross income of the poorest households."

Here is what the IFS say about the distributional impact of increasing the tax threshold to £10,0000 on different groups:

The poorest households:

Those individuals with incomes too low to pay tax will not gain at all from this. In 2009-10, only 62% of the adult population had a high enough income to pay income tax ... in any given year around one in four families contains no income tax-payer. But these figures are a reminder that income tax cuts are not well targetted to help the poorest in society.

The impact on low-paid income taxpayers:

In 2009-10 there were 3.6 million taxpayers with incomes below £10,000, paying a total of £1.1 billion in tax. Thus around 7% of the money spent increasing the personal allowance would go to these 3.6 million people, who would gain just over £300 per year on average.

The impact on most low, middle and higher-earners:

Those aged under 65 with earnings between £10,000 and £112,950 would gain £705 each.

The gains are much smaller for most pensioners who pay income tax, except that those pensioners earning over £23,000 would gain more, and pensioners earning over £29,000 would gain as much as middle-earners under 65:

Those aged over 65 currently have a higher personal allowance - £9490 for those aged 64-75 and £9640 for those aged 75 and over - and so an increased to £10,000 would mean a much smaller giveaway to them: £102 and £72 respectively ...

But above income levels of £22,900 older taxpayers would gain more, and those with incomes above £28,930 (if aged 65-74) or £29,230 (if aged 75+) would gain the full £705

So the IFS summarises the overall impact of the LibDem proposal to raise the tax threshold as follows:

Those with the lowest incomes would not benefit from this reform. And families with two taxpayers will benefit more than families with one taxpayer, who tend to be worse off.

Thus, overall, better off families (although not the very richest) would tend to gain most in cash terms from this reform.

But clearly £705 would be less valuable to those on higher incomes than to those on lower incomes as a percentage of income: the largest gains are around the upper-middle of the income distribution rather than at the top. In isolation, this giveaway could not be described as progressive, but to consider the distributional impact of the Liberal Democrats' package as a whole we must also consider who would lose from the tax rises they would introduce to pay for this tax cut ...

Broadly speaking, the Liberal Democrat package would redistribute from the well-off to middle-income families – augmenting the progressive pattern of Labour’s pre-announced measures but doing little for the poorest households.

The IFS graph of page 50 also show that LibDem tax credit and benefit changes would have a (smaller) negative impact on the middle income deciles, peaking at a loss of £100 a year for those in the 6th decile.

Overall, the IFS reports that "the LibDems would increase the size of the net 'takeaway' by about a quarter, and would do so in a way that would make the pattern of losses more progressive, by redistributing from the wealthy to those on middle-incomes (but not so much to those on low incomes)".


rwendland said...

Also this £10k proposal will not help the unemployment situation, though possibly only at the margins.

About 26% of UK workers are part-time, and the median income of UK part-time workers is £8,628. So the majority of part-time workers will be incentivised to increase hours to fully utilise the £10k income threshold - which will reduce job opportunities for others.

Unknown said...

So, in other words, the overall pattern under a Lib Dem government would be more progressive than under Labour, no? Since the elements of Labour's package which would benefit the poorest have been incorporated into the Lib Dem package? The IFS' 'augmenting the progressive pattern' does seem to be unequivocal about that.

Also, I do think the point about work incentives ought to be considered from a left-of-centre point of view. If you add income tax, employee national insurance and tax credit withdrawal rates together, you get 70% - 71% from next year - which must surely have a major impact. This is before we worry about employer national insurance, housing benefit tapers, council tax benefit tapers or anything else.

Now, obviously taking income tax out of that isn't necessarily going to revolutionise things for everyone - but surely it'll make an important difference for a lot of people who might otherwise find they'd be virtually no better off taking a job? And doesn't that help people get themselves out of poverty?

You can argue that the Lib Dem changes don't, directly, benefit the poor in cash terms - though that's a narrow measure; what about housing policy or electricity bills or insulation? But it's quite unfair to give the impression that Labour are giving lots of things to the poor which the Lib Dems aren't, when the measures are already prefigured in the Budget. The real difference is that Labour are promising practically nothing new in terms of tax and benefits on top of the April budget.