Monday 10 May 2010

Tories back LibDem tax plan - here's how David Willetts destroyed the argument for it

Michael Gove has confirmed that the Conservatives have offered to introduce the Liberal Democrat plan to raise the income tax threshold to £10,000 in a coalition deal.

Opinions differ among their political opponents about the value of the populist LibDem plan. The Fabians do praise how the LibDems raise their £17 billion - but, like the Institute of Fiscal Studies, are very sceptical about the claim that spending so much on raising the income tax threshold is the progressive policy on fair taxes.

Many Conservatives - especially on the right of the party, like Tim Montgomerie of ConservativeHome, Norman Tebbit - are very keen on raising the income tax threshold. All they oppose are the LibDem plans to raise £17 billion to do it - by higher taxes at the top and some optimistic projections on tax evasion.

John Redwood on Newsnight has said he is "delighted" with income tax cuts but suggests paying for this by spending cuts instead. Clearly, Liberal Democrats would be much less keen on the policy unless it did redistribute from the top to pay for the income tax cut.

As the IFS said:

"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."

So trading Tory support for their income tax threshold change for LibDem acquiescence to the Tory inheritance tax policy and marriage tax break, without introducing the LibDem mansion tax and other measures would be a very hollow claim to "fair taxes".

Perhaps the most convincing rebuttal of the tax threshold policy was published by progressive Conservative David Willetts, in his column Sorry Lord Saatchi, You're Wrong after the 2005 election, in response to right-wing Tory advocacy of the same policy.

It is well worth reading Willetts in full. Here's a snippet.

Low taxes increase living standards and give people more control over their lives. We have an obligation to help the poorest members of our society who have been let down by “bog standard” public services and declining social mobility.

There seems to be an obvious way of putting together these two powerful propositions — cut taxes for poor people. Maurice Saatchi is the most eloquent exponent of this view. It is rapidly becoming the conventional wisdom. But it won’t work. Trying to pull together two very different propositions just creates an almighty mess.

Many people assume that there is an easy way of cutting taxes and helping the poorest people — we should raise the income tax allowance. At the moment people start paying income tax at about £5,000 a year. What if we increased that to £10,000 a year — wouldn’t that transform the situation of the poorest people?

It is true that poor people pay a shockingly high amount of tax. The richest 20 per cent of households lose 35 per cent of their incomes in tax. The poorest 20 per cent of households lose 37.9 per cent of their incomes in tax. In fact the poorest 20 per cent pay a higher proportion of their incomes in tax than any other slice of the population. No one seriously planned for this bizarre outcome.

But the tax that poor people pay isn’t income tax. The poorest 20 per cent of households sacrifice 28.5 per cent of their income in indirect tax, of which the biggest single item is VAT. All direct taxes take 9.5 per cent and of this the biggest item is council tax, which takes 4.6 per cent. Income tax, taking 3.5 per cent of their income, is responsible for less than one tenth of the taxes paid by the poorest fifth of households.

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