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Raising the personal allowance

    Most media outlets are reporting this morning’s plea from Nick Clegg to raise the personal allowance to £10,000 more quickly. This is good news on four levels. First, as Maurice Saatchi and Peter Warburton argued in ‘Poor People! Stop Paying Tax!’ in 2001, the complex interaction between means-tested benefits and the direct tax system means that the poor quite often end up facing very high marginal rates of tax, which disincentivises work. Second, given that means-tested benefits are paid because low-earning individuals are considered too poor, it is morally unjust that they should pay tax. Third, low and middle-income families are facing huge strains on their living standards following the rise in VAT, fuel costs and inflation. Fourth, because of inflation, the quicker this policy is implemented, the larger will be the effect.

    For these reasons, the Deputy Prime Minister’s intervention should be welcomed. However, it is as yet unclear a) whether this will be adopted as Coalition policy for the Budget and b) how this will fit into the deficit reduction strategy.

    Given that George Osborne did not announce further spending cuts in the Autumn Statement following the downwardly revised growth forecasts, we are to assume that he is comfortable with a plan of closing the structural deficit by some time into this next Parliament. Working from this as a baseline, my rough calculations suggest that the policy will cost, if implemented, around £9 billion in 2012-13 (that’s £9 billion above the cost of raising the PA to £8,105 as already planned). This would be a tax break to the tune of £380 per individual for all earning between £8,105 and £100,000 – so it would be particularly helpful for families with two working parents.

    The Coalition would have two options in implementing the policy. The first is to borrow even more than planned to fund it, hope that there is more growth and plan for deeper cuts to spending in the next Parliament. The second is to raise revenue or cut spending elsewhere to pay for it now.

    It seems unlikely that Osborne would choose the first option. An unfunded £9 billion tax break would be a significant suggestion that he was unwilling to stick to even his watered-down deficit reduction plan.

    That leaves plugging the gap elsewhere. Nick Clegg’s suggestion is that a combination of closing loopholes and avoidance on stamp duty, coupled with more green taxes, could do the trick. This, to me, would not add up – unless Clegg was willing to only part fund the tax cut. He seems to have taken inspiration on the stamp duty from some of the eminently sensible suggestions made by Mark Reckless last year. But this would nowhere near fund a tax cut of this magnitude, and using green taxes to fill any hole would not only harm economic growth prospects, but would probably only lead to the very same low and middle income families shelling out more on energy and/or fuel bills. It would be giving with one hand to take with another.

    The Lib Dems stated policy aim is, of course, to introduce a new tax on wealth – a mansion tax on properties worth over £2 million. Conservatives are right to resist this. Most people of aspiration earn income in an attempt to become wealthy and acquire property. They pay tax on their income and use the remainder to invest. A mansion tax based on this property’s value is therefore not just double taxation, it is a discouragement to aspiration.

    Nor, in a liberal state, should taxes on wealth be used to coerce people into uses that the state considers ‘more productive’. Proponents of the tax argue that a mansion tax would target ‘unearned’ as opposed to ‘earned’ wealth, but there is no evidence to suggest that the state is particularly adept at distinguishing between the two. Consider the plight of the asset rich, income poor widow whose family prudently saved for years to buy the property of their dreams. Squeezing people to obtain higher yields after they’ve already met their income and consumption tax duties in order to alleviate injustice and fill the public purse seems a clear abuse of state authority.

    Since George Osborne has shown little appetite thus far for revisiting his Comprehensive Spending Review, this policy would seem to require changes to the tax system, however. The most obvious means would be to restrict pension tax relief to the basic rate, which on this year’s estimates would save about £7 billion per year. While many Conservatives would rather see deeper spending cuts (after all, it’s spending that’s too high), this seems the lowest hanging fruit in the forest for what is a noble cause.

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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