Tuesday 22 June 2010

Would it be "progressive" to cut income tax while hiking VAT?

VAT is a tax which hits the poorest hardest. As Tim Horton has noted:

The richest 10% pay one in every 25 pounds of their income in VAT; the poorest 10% pay one in every seven pounds as VAT

(Source: Office of National Statistics, References here).

Yet raising the income tax threshold does nothing for the poorest households.

As the Institute of Fiscal Studies pointed out in its manifesto analysis:

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.

It is being reported that George Osborne plans in today's budget to begin to increase the income tax threshold, but will exclude higher rate tax-payers from gaining alongside basic rate taxpayers. But seeking to mitigate the impact in that way does not change the fact that the government appears to be able to find £3.7 billion to spend on tax cuts despite claiming we are on the "road to ruin", yet has structured the giveaway in a way which excludes most of the poorest quarter of households, , who pay a very high proportion of their income in indirect taxes.

So, in its election analysis, the non-partisan IFS was very puzzled as to why the LibDem party which talked so much about the proportion of income paid by the poor in tax would focus so heavily on income tax threshold changes, even claiming to have "taken the poorest out of tax" on this basis.


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. 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 IFS analysis on who gains from raising income tax thresholds was very similar to the earlier critique published by Left Foot Forward and the Fabians.

Though this critique was vigorously contested by LibDems, nobody made any serious attempt to contest the evidence about where the gains of raising the tax threshold went.

Rather LibDems pointed to the progressive tax-raising policies, like the Mansion Tax, which were (then) going to pay for it, but which are mostly (now) no longer part of the picture.

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