“I repeated in the last Budget that we would introduce the 10p starting rate when it was prudent to do so. However, I have to tell the House that this 10p rate will not start in April 2000, like other income tax changes we are making today. It is prudent, instead, for people to get the benefit of the 10p starting rate now.” – Gordon Brown, Budget Speech 1999
In the March 1999 Budget, Chancellor Gordon Brown introduced the 10p rate of income tax, meaning that the UK’s income tax system then had four different marginal rates: 0%, 10%, 23% and 40%.
Since then, our income tax system has undergone some big changes. In his 2007 Budget, Gordon Brown abolished the 10p rate, whilst reducing the basic rate of income tax from 22p to 20p. As Prime Minister, Brown also introduced a new top rate of tax for those earning more than £150,000 per year at 50p, which the Coalition government has since reduced to 45p. And as another money raising measure, Brown tapered away the personal allowance at a rate of 50p in every extra £1 earned for those earning more than £100,000 (imposing an effective marginal income tax rate now of 60% for those earning between £100,000 and £118,880).
More recently, the Coalition government has made concerted effort to raise the personal allowance, lifting millions out of paying any income tax.
The net result of all these changes is that at the start of the next financial year in 2013/14, the UK income tax system will have:
- A personal tax allowance of £9,440 on which no income tax is paid
- A basic rate of 20% up to gross income of £41,450
- A higher rate of 40% from £41,450 - £100,000
- The withdrawal of the personal allowance from £100,000 and £118,880
- The additional rate of 45% on gross income over £150,000
Conservative MP and tax campaigner Robert Halfon has recently advocated the re-introduction of the starting 10p tax band for low earners. In an article for Conservative Home, he said:
“What is the best way to show that tax-cutting is the best way to redistribute wealth from the rich to the poor, to help eliminate the poverty trap and create incentives to work?... The answer is by showing that there is a moral mission for lower taxes — and the best, boldest, and most symbolic way would be to restore the starting ten pence band of income-tax, which Gordon Brown scrapped in 2008.”
This short note considers whether the re-introduction of the 10p rate is desirable in broad terms, and examines the relative effectiveness of the 10p rate in fulfilling Mr Halfon’s aims compared to an increase in the personal allowance of equal ‘cost’.
The economic effects of the rate
Robert Halfon is proposing that a new 10p rate be created between the personal allowance (£9,440) and £12,000. The income tax structure would then have five official rates: 0% (the personal allowance), 10%, 20%, 40% and 45%.
NOTE: the bump between £100,000 and £118,880 is due to the withdrawal of the personal allowance.
As Mr Halfon outlines in his article, the main effect of this would be to halve the income tax bill of all those earning between £9,440 and £12,000 – meaning someone earning £12,000 would, for example, see their income tax bill fall from £512 to £256. Full-time workers on the national minimum wage would see their income tax bill cut by around 37%. And of course, the marginal tax rate faced by workers earning less than £12,000 but more than £9,440 would now be 10% rather than 20%, giving many part-time workers a stronger incentive to work more. All other taxpayers earning above £12,000 would of course see a tax cut of £256.
So, in terms of the aims of improving work incentives and slashing the income tax burden for those on low incomes, Mr Halfon’s tax cut would seem to do the business.
The House of Commons Library suggests that implementation of this policy would cost around £6 billion in lost revenue, however. And this comes with what economists describe as an opportunity cost. If we have £6 billion for a tax cut to help the low paid, is the 10p rate the best way to improve work incentives?
If it is fair and right that low earners should pay less tax, then many would argue that it would be even more fair for poor people, particularly earning the minimum wage or below, to be taken out of tax altogether. This could be achieved by raising the personal allowance. Raising the personal allowance would also have a stronger effect on work incentives, because the marginal income tax rate faced by low earners would be 0% rather than 10%.
Mr Halfon of course rightly points out that raising the personal allowance to £12,000 would be much more costly than his proposal to reintroduce the 10p rate. But for the same cost as his proposal we could raise the personal allowance to £10,620.
All those earning between £9,440 and £10,620 would then pay no tax whatsoever, and would face a 0% marginal tax rate. Those earning between £10,620 and £11,800 would be better off than under Mr Halfon’s proposal, whilst facing a 20% marginal tax rate. And those earning more than £11,800 would now only get a tax cut of £236 rather than £256.
To summarise, raising the personal allowance to £10,620:
- would lead to lower marginal tax rates than Mr Halfon’s proposal for those with gross incomes below £10,620, but higher for those between £10,620 and £12,000
- would give a lower tax bill to all those earning £11,800 or less than Mr Halfon’s proposal, but a £20 higher tax bill for all those earning more than £11,800.
The political side
The re-introduction of the 10p tax rate has not been advocated on the usual conservative/liberal ground of economic liberty or efficiency alone, however. Like Gordon Brown back when the rate was first introduced in 1999, some conservatives advocate it on the grounds of fairness or social justice. It has been described as a ‘blue-collar’ policy, ‘moral’ and ‘symbolic’.
This somewhat suggests that the policy is being advocated as much on political rather than economic terms. It was ever thus. Back in 1999, Treasury officials complained that Brown was determined to introduce the lower rate in order to get Labour in on the Tories’ popular ‘tax cut agenda’. They complained that despite the arguments Brown made in favour of the new rate, the economic aims could be achieved more easily through other policy means.
One of the reasons that the editor of Conservative Home, Tim Montgomerie, has advocated the policy is to deliver a distinct Conservative achievement, given most of the popular press and public credit the Liberal Democrats with the increase in the personal allowance (a proposal which was originally advocated by Maurice Saatchi and Peter Warburton for the CPS as far back as in 2001).
In truth, much of the debate about the 10p rate has therefore always been political. Indeed, despite the inevitable political assault from the Conservatives when Brown abolished the tax in 2007, many Conservatives had previously intimated that the 10p rate was a ‘gimmick’.
Yet lowering the tax burden on low paid workers, particularly those facing squeezed incomes, is a noble aim. The policy therefore deserves fair hearing.
Unique arguments in favour of the 10p tax policy
As outlined above, there are clear arguments in favour of the 10p tax policy in its own right from both economic efficiency and moral perspectives. However, one must compare the policy with cost-equivalent alternatives, such as raising the personal allowance. Then, its desirability becomes less clear-cut.
One unique justification made by Tim Montgomerie for its re-introduction, as opposed to further increases in the personal allowance, is that ‘We want most Britons to feel the burden of the state's expenditure.’ This is a variation of the argument of the IEA’s Mark Littlewood, that raising the personal allowance too high protects someone from the tax system such that they have no incentive to vote for fiscal responsibility.
Arguments against the 10p tax policy
The above argument has some merit, yet one could rightly counter that there does not seem to be much morality in taxing people on very low incomes only to hand them back significant amounts in benefits. You could also highlight that the justification assumes people aren’t very aspirational and do not worry about the potential tax burden they would face if their incomes increased.
There are four other reasons to object to the 10p rate policy over a personal allowance increase, however.
First, the 10p rate would add further complexity to the tax system. If it was introduced, we would have moved from an income tax system (not to mention National Insurance) with three marginal rates in the last years of the Thatcher government (0, 25, 40) to five marginal rates (0, 10, 20, 40, 45) now, and six if you include the withdrawal of the personal allowance between £100,000 and £118,880. When the 10p rate was first introduced in 1999, Edward Troup, then Head of Tax Strategy at Simmons & Simmons Solicitors, and now Tax Assurance Commissioner at HMRC, told the Treasury Committee that
"a perfectly simple tax system delivering whatever tax you want to almost anybody can be delivered with personal allowances and two rates of tax".
It’s difficult to see why this should be so different now. What’s more, just after the 10p rate was abolished, Robert Chote (of the Office for Budget Responsibility), in his previous role at the Institute for Fiscal Studies said:
“The 10p band should never have been introduced in the first place. It complicated the income tax system and was poorly targeted on those it was claimed to help.”
Second, the main problem that we envisage is not so much any administrative complexity, but willingness for Chancellors in Budgets to tinker with thresholds for different marginal rates in order to take from one group to give to another. We have already seen evidence of this earlier in this Parliament, with the Coalition government part funding increases in the personal allowance by lowering the starting threshold for the 40% higher rate. By creating another readily identifiable group of low earner income taxpayers, the policy would therefore accentuate pressure to drag more and more into higher bands, with higher marginal rates, in order to fund so-called ‘fair’ tax cuts for lower income groups going forward.
Third, the addition of another marginal rate makes it less likely that a consensus will be achieved for broad-based tax cuts of the sort carried about by both the Thatcher and Reagan administrations in the 1980s. In particular, it would undermine attempts to move towards a simpler, flatter tax system – particularly if a future government sought to merge fully income tax and National Insurance contributions.
Fourth, the real problem with marginal tax rates for many low income groups is not due to income tax but to tax credit withdrawal. A full review of the tax credit system, with a move to an earned income tax credit like that accelerated in the US under the Clinton administration, would do far more to aid work incentives than the introduction of the 10p for a narrow band of income. While the universal credit system will help those in the ‘unemployment trap’, for whom work doesn’t pay, more still needs to be done to address the ‘poverty trap’ – that low paid workers can face extremely high effective tax rates as their tax credits are withdrawn when their working incomes increase.
It is good to hear a Conservative MP forcefully make the moral case for lower taxation, particularly for those with low earnings and trapped in relative poverty by the complex interaction of taxes, benefits and tax credits. Robert Halfon MP has done much good work to trumpet the case for an increased personal allowance (and for preventing hikes in fuel duty). But would the re-introduction of the 10p tax rate be a wise policy move for the Conservatives to adopt were the finances available for it to be achieved?
Whilst the political appeal is obvious, the economic benefits for the very low paid can be better met by further increasing the personal allowance. What’s more, the policy risks in the longer term giving politicians further scope to drag increasing numbers into higher marginal rate bands in the name of ‘fairness’, whilst further complicating the personal tax system. It would be preferable in the immediate term to focus on further rises to the personal allowance, merging income tax and National Insurance to promote tax transparency, seeking to reform the tax credit system towards an earned income tax credit system with less punitive deduction rates, and trying to take people back out of the 40% tax band.