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Increasing the Personal Allowance is still a powerful tool

    It was mildly amusing to see the Lib Dems recently complaining that the Conservatives were claiming the credit for having increased the Personal Allowance. They seem to have forgotten that it was the Centre for Policy Studies which first proposed increasing the Personal Allowance to £10,000 back in 2001. This week, the threshold was increased again which means that we can now earn £10,600 a year before we pay income tax – up from £6,475 at the last election. As a result of this big income tax cut, people working normal hours on the minimum wage have seen their take-home pay rise by 20% over the past five years.

    Increasing the Personal Allowance is, for good reason, a major component of the tax policies of the Conservatives, UKIP and the Liberal Democrats. By allowing people to keep more of the money that we earn, such an income tax cut will increase the rewards of working and encourage people to get back into work. Others who are already working but are considering leaving the labour market due to the extra travel costs or childcare costs will find that the balance is tipped in favour of work. As well as the supply-side boost of rewarding work and increasing job creation, it will ease the pressure on household budgets – many of which remain stretched. This tax cut should be applauded and proposals for further such tax cuts in the next Parliament should be welcomed.

    Some people, on both the Left and the Right have criticised the big increases in the Personal Allowance over recent years. Tim Wigmore at the New Statesman has condemned it because it is not progressive in his view. On the Right, some have argued that it is a bad idea because they believe that taking people out of tax altogether makes them less likely to vote for tax cuts in the future. Both arguments are misguided.

    As I have pointed out previously, even on a static basis, the percentage increase in family income is the biggest for lower income groups. The poorest 3rd, 4th, 5th and 6th deciles of workers would see the biggest increases in family income if the personal allowance rises to £12,500. Furthermore, the poorest 40% of workers would see the biggest percentage point cuts in their effective marginal tax rates – boosting work incentives. Of course, those earning below the income tax threshold wouldn’t see any static benefit. However, that is missing the point. For those people who are not working, the income tax cut wouldn’t benefit them directly but would incentivise them to enter the labour market and to get a job. This process must have played some part in generating the UK’s record employment rate.

    The same incentive applies to people who are below the threshold but working part time. It is worth remembering that the ONS figures show that the proportion of part-time workers who don’t want a full-time job has remained fairly constant at about two thirds. The percentage of part-time workers who could not find a full time jobs has fallen from 18% two years ago to nearer 16% now. Whilst further rises in the Personal Allowance might not benefit this section of the workforce immediately, the dynamic effects of higher employment and disposable incomes will be felt across the economy.

    Yes, the National Insurance threshold is below the income tax threshold and there are approaching 1.5 million people who pay NI but not income tax. Raising the National Insurance threshold should therefore be a priority. However, that does not need to be at the exclusion of further increases in the personal allowance. Also, it does show the absurdity of critics of raising the Personal Allowance who say it will make people less likely to vote for tax cuts. Just because they don’t pay income tax doesn’t mean that they don’t pay other taxes.

    The Conservatives and Lib Dems have pledged to raise the Personal Allowance to £12,500 in the next Parliament and UKIP has said it would go further. Meanwhile, Labour has pledged to bring back the 10% income tax band. Labour’s 10p rate is frankly an inferior policy because whilst it introduces new complexity and administrative costs through a new tax band, it doesn’t actually achieve anything that a higher Personal Allowance couldn’t do better. As the IFS has argued, it “has no plausible economic justification”.

    At the same time, it is clear that Labour needs to raise taxes to meet its deficit reduction targets. Freezing the Personal Allowance might therefore be a tempting stealth tax for the party. Such a policy would damage work incentives, employment growth and cut the disposable incomes of low and middle income families. The party should rule out such a freeze. 

    Adam joined the Centre for Policy Studies as Head of Economic Research in January 2014. 

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