Wednesday 12 May 2010

Tax fairness? How raising the tax threshold just got much less progressive

The Fabian Society and Left Foot Forward research from Tim Horton and Howard Reed showed that the LibDem plan to raise the income tax threshold to £10,0000 would redistribute most to middle income and relatively affluent households, while doing little or nothing to help the poorest.

The Institute of Fiscal Studies agreed - noting that "the Liberal Democrat package would redistribute from the well-off to middle-income families ... 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".

The Fabian research argued that the LibDem plans to raise the £17 billion at the top merited support - but this was a poor progressive choice about how to spend that.

However, the LibDem blogosphere mounted a spirited defence of the policy. Not by disagreeing, but by arguing that the measures to fund it - including the mansions tax, reducing pension tax relief for higher rate payers and green taxes - meant it was redistributing to the middle from the top of the income range.

James Graham wrote:

The fact that raising the tax threshold helps people on higher incomes more than people on low incomes is not, believe it or not, a startling revelation. We know. The party has never tried selling this policy in isolation; we’d be mad to attempt to because people would rightly ask where we propose trying to find £17bn.

By contrast, Tory right-wingers like Tim Montgomerie, Norman Tebbit and Guido Fawkes praised the reduction in income tax (while criticising LibDem plans to pay for it) though other Tories including David Willetts and Michael Howard had argued in 2005 that raising tax thresholds was not a fair way to reduce taxes because this does so little for the poorer households who pay the highest proportion of their income in (mostly indirect) taxes.

Where are we now? It sounds as if we are heading primarily towards the Tory right's version of the plan, though we shall have to look at the detail when it is released. It seems that the Conservative and Liberal Democrat government will prioritise increasing the tax threshold "as resources allow". The LibDems have dropped the mansions tax, though it is reported that a version of their capitals gains policy has been agreed.

We await the details but it is reported that most of the initial downpayment on the pledge will come from continuing with an increase in employee national insurance that the Conservatives had said they would reverse. We shall have to see the detail to look at the winners and losers from that specific change: Stephanie Flanders suggests it could be a "symbolic change": it sounds as if this means an element of relabelling for many tax payers, while nominally increasing the threshold. Other resources will be needed.

I'm told that this increase in the allowance will be significant, costing more than the rise in the employee threshold which it replaces - though nothing like the nearly £17bn it would cost to go all the way to £10,000. They will need to raise money from somewhere else as well, but the bulk of the money will come from not implementing that piece of their national insurance cut.

For many taxpayers, the difference will be fairly academic ... But clearly, this was an important symbolic concession for the Liberal Democrats.

To the extent that a good chunk of this turns out to be a nominal change, then this might now sound like a case of much ado about nothing. Except that the Tory NI money being released here is funded by cuts in public spending. And the LibDems are reported to be agreeing to earlier Tory cuts this year which Vince Cable criticised so sharply during the campaign. Public spending has a pro-poor redistributive effect

And this initial switch from income tax to employee national insurance won't get to £10,000 or £17 billion. So the big question will be where the resources come from - and how far this compounds or mitigates the regressive features of a taxation policy focused primarily on raising tax allowances.

The Left Foot Forward research showed that, even considering the overall LibDem package, this would increase relative poverty and socially damaging inequalities between the bottom and the middle, while reducing it between the middle and the best off. The Solidarity Society showed why a range of alternative approaches were much more progressive than raising tax thresholds.

The outcome suggests it was legitimate to study the individual elements of the LibDem tax package. The third party was always going to have to pick and choose if involved in post-election negotiations on what it calls "tax fairness".

It was easy to predict that the Tories were much more attracted by the progressive-sounding tax threshold change than the actually progressive tax increases which paid for it.

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