Raising the income tax threshold – proceed with caution

As Liberal Democrats build our manifesto for 2015, one key policy is already being promoted as a flagship measure – continuing to raise the income tax personal allowance to £12,500. While there’s little doubt that raising it to £10,000 in this Parliament was a significant, liberal and popular achievement, we should proceed with caution in going yet further – particularly in light of the often-unwelcome consequences and alternative options, as set out in an excellent CentreForum paper by Adam Corlett. This paper is a significant contribution to a much-needed discussion on the costs, benefits and alternatives to what many in the party assume is a done deal on tax thresholds – it is right and proper that we subject all policy to real scrutiny.

Few would disagree that taxation should be fair, and that the lowest earners should shoulder as little of the strain as possible. But in lifting the income tax threshold yet further, we should ask three key questions that ought to apply to virtually any tax policy:

  1. Do the lowest earners in fact stand to benefit at all? Where does the benefit of a higher personal allowance accrue?
  2. Tax cuts have to be weighed up against the costs in terms of further public spending cuts or higher taxes elsewhere needed to fund them – what is the trade-off required to achieve a £12,500 allowance?
  3. If the aim is to lift low earners out of tax, what alternative measures are better?

Adam’s CentreForum investigation concludes that there are significant opportunity costs which must be accounted for – I would emphasise the further erosion of already-stretched public services, which could impact a great deal on millions of low earners. As is well-established through the work of the Institute for Public Policy Research and the Resolution Foundation, Adam reports that higher and higher personal allowances do not in fact benefit the very poor as much as they do middle- and higher-earners. An interesting finding in this work is that through interaction with Universal Credit, childcare policy and automatic enrolment in workplace pensions, a higher personal allowance could well be of little benefit for many low earners – and indeed could damage future prospects in terms of their pensions. These are strong arguments in favour of a real public debate on how best to shape our tax and benefit system.

There is a compelling argument in favour of raising National Insurance thresholds rather than income tax allowances. If the aim is indeed to help low earners, and to simplify the tax system, this should be a real priority – from what I can see this would be a far more effective and fairer tax cut.

There’s also an elephant in the taxation room – if make the (questionable) commitment to finding at least £25bn more cuts en route to a balanced budget, the opportunity cost of tax cuts on this scale rises yet more. Considered alongside fiscal consolidation that the Institute for Fiscal Studies already considers undeliverable, substantial tax cuts that don’t help low earners cannot be the priority.

All three political parties are looking to boost the living standards of low- to middle-earners, which social liberals of course welcome as a long-overdue focus. Liberal Democrats must ensure a fully-informed, open debate on how best to achieve this without falling back on simplistic assumptions that higher income tax thresholds are necessarily the best way forward. As the aim is to foster a fairer, more sustainably prosperous political economy, we should examine all our options with an open mind.

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4 comments on “Raising the income tax threshold – proceed with caution
  1. Happy to agree that the national insurance threshold should be a greater priority than increasing the personal allowance for income tax further.

    Perhaps consider offsetting the cost of increasing the lower boundary for beginning payment by uplifting the upper boundary beyond which high earners make no NI contributions?

    I think to dismiss the possibility that further public expenditure savings can be made would be unjustifiable, although making further savings in the next parliament may most easily be achieved by targeting the Tory sacred cows that have so far been protected at the cost of greater cuts elsewhere.

  2. Joe Otten says:

    I agree that NI is now a better place to raise thresholds.

    But I would make two comments on Adam’s paper.

    1. Adam analyses impact by household on cuts to taxes on individuals. This does not give a clear picture of the effect on individual incomes. Unless you believe in and will advocate the household income as the basis for taxation rather than the individual income, you are just going to muddy the waters adopting this sort of analysis.

    2. There is a suggestion that raising the personal allowance has contributed to relatively strong employment growth. If true, this is a good effect of the policy that outweighs all the stated concerns.

    • Adam says:

      Thanks Joe. On the first point, it’s much more meaningful to look at households if we’re trying to consider actual living standards. That’s why the government, the IFS and other think tanks all favour the household approach. And even looking at the tax cut on an individual level, it’s only progressive if you exclude the half of the UK population that doesn’t pay income tax, and doesn’t mean there aren’t more progressive options.

      Similarly on the second point, any extra employment (if any) doesn’t necessarily justify the policy, as it may be that NI cuts, not raising VAT, or even upping benefits (to say nothing of education etc.) would have an even greater effect on jobs for a lower cost.

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