This week’s budget contained few surprises. Least surprising of all was the announcement of a further rise in the income tax threshold for working-age people. From next April, the personal allowance rises to £9,205, generating a tax cut of £220 for all basic rate taxpayers earning more than the current allowance of £8,105. The Liberal Democrats have lobbied hard for this move as part of their “fairness” agenda, arguing that the higher allowance lifts 840,000 low earners out of income tax altogether. At the other end of the scale, part of the gains for higher rate taxpayers have been restricted, which helps to offset the cost.
Nevertheless, this remains an expensive measure, at £3.3 billion next year. Any tax cut spread across 24 million taxpayers will be expensive if it is to have a significant impact on individual incomes. Some of this cost has been offset by scrapping higher allowances for pensioners (the much criticised ‘granny tax’), and a higher bank levy and changes to stamp duty will make some contribution. But was this the best way to spend £3.3 billion when money is so tight?
Two points about the higher personal allowance suggest it was not. First, the struggling economy is crying out for a quick and temporary stimulus to boost consumer demand, which raising the personal allowance fails to deliver. The increase will not come into effect until next April, but with unemployment at a 17-year high and rising, we need a boost now, not in 12 months’ time. The higher threshold will be permanent (and very likely to increase even further), eroding the UK’s tax base in the long term when the future pressures on public spending mean we should be doing everything we can to protect tax revenues. An immediate but reversible cut in the main rate of employees’ national insurance would have been much more effective.
Second, the Liberal Democrats’ assertion that a higher personal allowance represents “fairness” in the tax system is open to question. The chart below shows how families benefit from the announcement according to their income. A higher personal allowance is progressive across individuals because it gives most basic rate taxpayers a flat rate amount. But across families, the change is less clearly progressive, with families in the middle of the income distribution gaining the most in relative terms. This is because these families are more likely to contain two taxpayers, so they get double the benefit, while families towards the bottom of the income distribution are more likely to have adults who are not working or not earning enough to benefit from a higher tax allowance. Someone working 25 hours a week on the minimum wage (£6.19 an hour from October 2012) earns less than the existing allowance, so will not see any gain when the tax threshold rises.
There is a strong case for an immediate and temporary economic stimulus to lift demand and stop unemployment rising in the UK. Labour market data from the US suggests that President Obama’s payroll tax cut has helped to boost jobs and growth. A stimulus needs to get money into people’s pockets as quickly as possible, focused on those who are likely to spend rather than save. This might not always be straightforwardly progressive, and this has to be balanced with speed and reversibility. A higher personal allowance fails on both points: it is neither straightforwardly progressive,
nor does it deliver a quick and temporary economic boost.
Kayte Lawton is Senior Research Fellow at IPPR