The popular middle-class income tax cut that the LibDems won't own up to

My colleague Tim Horton examines the distributional impact of the Coalition's income tax cuts, through the policy of gradually increasing the tax threshold to £10,000, in a post for Left Foot Forward.

As Tom Clark of The Guardian noted "the IFS confirmed that the bulk of the gains accrue to childless families in the top half of the income distribution, particularly couples who both work", rather at odds with the focus on claiming that the policy was mostly about "taking the poor out of tax".

But James Forsyth of The Spectator doesn't disagree with that - but recently looked at the issue through the other end of the telescope. He noted that the importance which the LibDems place on claiming that the Coalition's income tax cuts are primarily about taking low earners out of tax has prevented the Tories emphasising that the tax threshold policy commits the Coalition to an extensive programme of middle-class tax cuts.

Take the plan to raise the income tax threshold to £10,000. The coalition talks about this Liberal Democrat idea as something that helps the low paid by lifting them out of tax altogether. This is true, of course, but it is less than half the story. The total cost of this change will be just over £17 billion, and £16 billion of that will go to those who earn over £10,000 a year: you still benefit from this change if you earn £40,000 a year as your amount of tax-free income is increased. But the Liberal Democrats do not like to stress this point because they want to portray the reform as a policy designed to help the poor.

In this year’s Budget Osborne began the process of raising the threshold to £10,000, but he combined it with a freeze in the allowance for higher rate tax-payers. Even with this change, the policy benefits anyone who earns less than £44,000 a year. But coalition ministers are still reluctant to go on television to talk about how they have cut taxes for the middle classes.

Hence too the Labour party's reluctance about ministers publicly challenging the LibDem policy during the election campaign. (At least some New Labour advisers who were instead rather more tempted to seek to emulate the LibDem policy, despite analysis from the Fabian Society, IFS and other civic society voices about its distributional impact).

So the policy was electorally effective, though the idea that raising tax thresholds would help to reduce the tax burden on the poor was most eloquently demolished by David Willetts, now a Tory cabinet minister, when debunking the fashion on the right for Maurice Saatchi's increased tax threshold proposal back in 2005, which Willetts noted seemed to be fast becoming right-wing "conventional wisdom" at the time.

As Willetts wrote in the Times:

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. If we really wanted to cut the taxes poor people pay we would be looking at indirect taxation ...

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.

Public concerns about the regressive impact of the threshold increase did lead, after the election, to higher rate taxpayers being excluded; this mitigates the proposals impact on income inequality. (It is worth noting that the LibDems in opposition did have a set of progressive taxation measures, such as the Mansion Tax, so that the top 10% met most of the cost of increasing the threshold: most of these progressive tax changes were dropped in Coalition negotiations, beyond a compromise on capital gains tax and the modest banking levy. So earlier attempts to defend the tax threshold increase in the context of this "fair taxes" package are considerably weaker because of the Coalition's joint decisions about which could be agreed).

Forsyth also noted that the battle for the 'squeezed middle' will be an important political battleground in the policy and political debate about how to reduce the deficit.

Sensing weakness, Labour’s leadership contenders have already started talking about how the government is trying to take away the middle-class bits of the welfare state. They point to how child tax credits have been taken away from those on more than £30,000 a year and how the winter fuel allowance is going to be restricted. Whichever Miliband becomes leader, the idea that the coalition is short-changing the middle classes will be a major part of Labour’s critique of the government. Counter-intuitive as it may seem, Labour aims to emerge as the protector of the middle classes from the coalition cutters.