Tax

Missing the target: tax cuts and low to middle income Britain

Adam Corlett
Adam Corlett
Matthew Whittaker
Matthew Whittaker
Gavin Kelly
Gavin Kelly

This report has two main objectives. First, to assess the main political parties’ leading proposals on tax cuts for the next Parliament. Second, to consider whether there is a different approach to that advocated by the main parties that would better serve low and middle income Britain.

Key findings

  • Over the course of this Parliament, huge priority has been given to raising the income tax threshold, ostensibly – in the face of declining living standards – to help workers on low pay and low to middle income households more generally, with much being made of the number of people ‘taken out of tax’. The coalition has increased the personal allowance from £6,475 in 2010-11 to £10,500 in 2015-16.
  • Despite the highly challenging fiscal environment, the four main parties have proposed further income tax cuts for the next Parliament: a £12,500 allowance by 2020 from the Conservatives and Liberal Democrats, a £13,500 allowance from UKIP, and a much more limited re-introduction of a 10p tax band in Labour’s case. Each of these policies is poorly targeted on low and middle income households: the clear majority of the gains go to the top-half of the distribution in all instances. In addition, the Conservatives have pledged to raise the higher rate threshold to £50,000 and UKIP to create a new 35p tax band on incomes between around £47,000 and £61,000 (based on a desire to initially introduce a band between £42,285 and £55,000 in 2015-16). These additional measures are highly regressive.
  • Taken together, the parties’ proposals result in between a third (Labour and Liberal Democrats) and approaching a half (UKIP and the Conservatives) of the overall gains flowing to the richest 20 per cent of households. In all instances, no more than one-quarter of the cost of the plan is accounted for by the entire bottom half of the income distribution. Crucially, this analysis ignores the potential distributional effects associated with raising the funds necessary to deliver on these promises: the distribution of gains is likely to be amplified or mitigated depending on the approach taken.
  • Despite the stated focus on helping low earners and struggling households, none of the parties’ proposed tax cut policies are of any benefit to the nearly five million lowest paid employees who pay no income tax. Within this group, an estimated 1.2 million will be paying employee National Insurance from April 2015 (expected to start at just over £8,000) but will be earning too little to pay income tax. Under the proposed increases in the personal allowance in the next Parliament their number would swell to between 1.6 million (Conservative and Liberal Democrat policies) and 2.1 million or more (UKIP). None of these low-earning ‘taxpayers’ will receive any gain from the proposals of the four main parties.
  • In contrast to the focus on tax cuts, the parties have given little attention to the role that in-work benefits can play in supporting those on low and middle income households in the next Parliament. Over 10 million individuals and more than 4 million working families will be eligible for the new Universal Credit – which all parties have committed to introduce. Yet little has so far been said in this area.
  • Within Universal Credit, the ‘work allowance’ serves a similar role to personal tax allowances: below the allowance, recipients keep all their earnings from work; above it, awards will be rapidly withdrawn at a taper rate (in effect a tax rate) of 65 per cent. In contrast to the personal allowance, the generosity of the work allowance has been cut over the course of this Parliament (with further cuts planned).
  • If we really want to help working families on low and middle incomes, boosting the work allowance would be more effective, and better value for money, than any tax cuts. For example, a £1,000 increase in the work allowance available to a single parent earning £12,000 and in receipt of housing support would boost their income by £650 a year. In contrast, a £1,000 increase in the personal allowance would benefit them by just £70.
  • The parties’ current focus on income tax is even harder to rationalise given that the design of Universal Credit collides with tax cuts. Because the 65 per cent taper is applied to a household’s net income, two-thirds of the intended gains from any tax reductions will automatically bypass all households eligible for Universal Credit. That is, every £1 gain associated with a tax cut results in a 65p reduction in their Universal Credit entitlement.

Recommendations

  • We favour a different approach – fully funded tax and benefit reform that is genuinely geared towards low and middle income households:
    • Prioritise improvements in the Universal Credit work allowance above all else. This is the most targeted and cost-effective way of supporting millions of struggling working households.
    • Adjust Universal Credit so it is tax-cut friendly. Without this, tax cuts will largely bypass several million hard-pressed working people.
    • Raise the National Insurance threshold in real-terms over time so it aligns with the personal tax allowance, prioritising this over any further hikes in the personal allowance. This would rectify existing anomalies, simplify the system and be less regressive than increasing the personal allowance. Because National Insurance is only payable on earned income and by those of working-age, it would restrict gains to this group who have done less well than retired households over this Parliament.
  • Combining these approaches would provide a big boost to low and middle income households. The biggest winners would be in the bottom half of the income distribution, among families with children and those of working-age. This contrasts markedly with the proposals of all the main political parties.
  • We don’t propose these measures should be paid for via yet deeper unspecified cuts. Nor do we want to rely on populist taxes that may fail to raise the desired revenue. Instead we propose a package of revenue sources: a three-year freeze in the personal allowance, a two-year freeze in the basic rate limit (and, by implication, the higher rate threshold) and the introduction of National Insurance payments for those working above the state pension age. Losses associated with these policies would be more than offset for the great majority of households by the combined gains flowing from raising work allowances and increasing the National Insurance threshold.
  • In the event that the economy grew more quickly than expected and the fiscal situation therefore improved more rapidly than we would expect, an alternative package could be introduced that was less reliant on an offsetting freeze in the personal allowance. Equally, if the economy instead fared less well than is currently supposed, then a worse than expected fiscal situation may mean that it is judged to be the wrong time to be considering any form of tax cut or increase in benefit spending – even a fully self-funding one such as the package we set out.

Further reading

More, more, more
Putting the Autumn Budget 2024 decisions on tax, spending and borrowing into context
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Camron Aref-Adib, Mike Brewer, Molly Broome, Tom Clark, Alex Clegg, Nye Cominetti, Adam Corlett, Emily Fry, Sophie Hale, Lindsay Judge, Zachary Leather, Jonathan Marshall, Charlie McCurdy, Louise Murphy, Felicia Odamtten, Cara Pacitti, Simon Pittaway, Hannah Slaughter, James Smith, Greg Thwaites, Lalitha Try
Revenue and reform
What tax changes could – and should – we see in Autumn Budget 2024?
·
Adam Corlett
Growing for gold?
Analysing the tax and spend package of the 2024 Labour Manifesto
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Molly Broome, Nye Cominetti, Emily Fry, Tara Goatley, Charlie McCurdy, Simon Pittaway, Hannah Slaughter, James Smith, Lalitha Try
Adam Corlett
Adam Corlett Principal Economist
Matthew Whittaker
Matthew Whittaker
Gavin Kelly
Gavin Kelly Executive Chair