Main parties misrepresenting who will gain from tax cuts in next parliament

Resolution Foundation calls for improved in-work support and alignment of National Insurance threshold with the Personal Allowance to support households on low to middle incomes

The income tax cuts proposed to date by the main parties are set to largely bypass low to middle income Britain – the very households they claim to be helping – according to a new report published today (Monday) by the independent think-tank the Resolution Foundation.

Despite the challenging fiscal environment, all the main parties have proposed further income tax cuts in the next parliament. The Lib Dems and Conservatives have pledged a £12,500 Personal Allowance (PA) by 2020, rising to £13,500 with UKIP. Labour are committed to a new 10p tax rate. The Conservatives have also pledged to raise the Higher Rate Tax (HRT) threshold to £50,000 by the end of the parliament, while UKIP want a new 35p tax band, initially between £42,000 and £55,000.

Missing the target: tax cuts and low to middle income Britain – the first in a series of detailed policy proposals by the Resolution Foundation – costs and analyses each of the parties’ income tax plans, which range greatly from below £1bn to at least £13bn. It finds that households on low to middle incomes gain relatively little from their policies.

Of every pound spent on their proposals, around a quarter goes to households in the bottom half of the income distribution under the Labour and Lib Dem approaches. Under UKIP and the Conservatives, around a fifth goes to the bottom half. Instead, the richest twenty per cent of households account for the largest share; gaining around a third of every pound spent under Labour and the Lib Dems, rising to approaching half under UKIP and the Conservatives. None of the parties’ tax proposals benefit any of the country’s five million lowest-paid workers who earn under the PA.

The report shows that there are far more targeted and cost-effective ways of supporting those on low to middle incomes. Raising Work Allowances in Universal Credit (UC) would help 3.4 million working families by allowing them to keep more of their earnings as they rise.

The Resolution Foundation also argues that increasing the employee National Insurance (NI) threshold so that it catches up with the PA would be preferable to income tax cuts. The gains would be more evenly spread – helping the 1.2m ‘forgotten’ workers earning between the two tax thresholds who pay NI but don’t benefit from income tax cuts. The benefits would be concentrated among workers below state pension age who have been hardest hit over recent years, rather than spread among retired households, landlords and those benefitting from other investment income. Aligning the two tax thresholds would represent a major simplification of the tax system.

The report also highlights that the current focus on tax cuts collides with the design of UC. Eligible working families stand to lose two-thirds of any cash gains from future tax cuts as their UC entitlement will be automatically cut. The Resolution Foundation is urging all parties to commit to addressing this by adjusting UC so that the full value of future tax cuts reaches these working families.

The analysis shows how a different set of tax and benefit priorities could benefit those on low to middle incomes. The Resolution Foundation’s fully funded package would raise the incomes of 3.4 million working families by increasing the Work Allowances in UC by 20 per cent. It would also see the NI threshold rise rapidly to just under £11,000 by the end of the next parliament, the same level as the PA. Together this would provide a cash boost to some families of up to £530.

To pay for this the PA could be frozen for the first three years of the next parliament and the basic rate limit for two years, while NI is extended to those working beyond the state pension age. The great majority of households would gain from this package, particularly those in the bottom half of the income distribution, though the richest fifth of households would lose out.

Gavin Kelly, Chief Executive of the Resolution Foundation, said:

“At a time of prolonged austerity it is striking that all the main parties are promoting tax cuts. There are big differences between them: the costs vary greatly and some are funded while others aren’t. But they all share one thing in common – the clear majority of the gains flow to better off households.

“Around five million of the lowest paid workers will gain nothing from any of the parties’ proposals – including 1.2 million who still pay tax in the form of National Insurance. This large chunk of working Britain, together with those on low and middle incomes who do pay income tax, would be better served by proposals that would improve work incentives within Universal Credit and cut their National Insurance bill.

“At the very least the next government must end the anomaly whereby Universal Credit recipients – including half of all families in the country with children – will automatically lose two-thirds of any gains associated with a tax cut. All the more so as we are being sold tax-cuts on the basis that they are aimed at helping hard-pressed families.

“With the economy set to dominate the coming election, parties need to be straight with the electorate about the real winners and losers from the policies they’ve set out. We need to avoid tax pledges that we can’t afford, skewed towards the better off, paid for by those who are already hard-pressed.”

Distribution of gains per £1 spent by household income decile under each party’s proposal and Resolution Foundation’s preferred approach

Notes:     Distribution of gains per £1 spent on the different proposals. This chart  ignores the fact that the parties are proposing different-sized giveaways, though the estimated costs (in 2020) are included in brackets below for information, and that finding the funds for these measures must involve further distributional choices. Conservative proposal raises the PA to £12,500 and the higher rate threshold to £50,000 (cost £7bn); Lib Dem proposal raises the PA to £12,500 (cost £5bn); Labour re-introduces the 10p starting rate of income tax on the first £300 of income above the personal allowance (cost £900m); UKIP proposal raises the PA to £13,500 and introduces a new 35p rate of income tax starting at the current higher rate threshold and continuing up to £55,000, whereupon the 40p rate becomes payable (cost a minimum of £13bn). Full details of the RF preferred approach are set out below. Deciles 8 to 10 are not in the RF band as losses among them pay for the gains across the rest of the income distribution.

Sources:  RF analysis using the IPPR tax-benefit model

• Universal Credit is expected to be in operation towards the end of the next parliament – a similar timeframe to the tax cut policies of the main parties.
• The Resolution Foundation analysis estimates that by April 2015 there will be 4.8m earning below the PA of £10,500, 1.2m of whom earn above the NI threshold – expected to be around £8,000 – and therefore still pay some tax.
• Under the Resolution Foundation’s proposal those above pension age who are still in work would become liable for NI on their earnings. This would not mean people paying NI on their pension income.
• Work Allowances in UC operate in a similar way to the PA in that they allow households to keep all of their UC entitlement as their incomes rise. Once their Work Allowance has been used up their UC entitlement is tapered away as their earnings increase.

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