Cutting income tax may be popular. But does it make economic sense?
ONE OF the most striking policies of Britain’s coalition government has been cutting income tax. Since 2010, the personal allowance, the amount each individual can earn before they start paying tax, has been increased from £6,475 ($9,518) in 2009 to £10,000 last year. This year’s budget, delivered by George Osborne, the chancellor of the exchequer, on March 18th, announced it will rise a further £1,000 by 2017, costing £2.7 billion. “It’s a tax cut for 27m people and means we’ve taken almost 4m of the lowest paid out of income tax”, he said.
At first, it seems strange that a government implementing such severe austerity measures has found room for tax cuts. That is because the government has been quietly shifting the burden of taxation from direct levies to indirect ones, at the fastest rate since the 1980s. Since 2010, £64 billion of tax rises introduced have offset by tax cuts worth £48 billion.
The government’s enthusiasm for raising the personal allowance derives from its political popularity. Almost 83% of voters support the idea, according to a survey released on March 18th by YouGov, a pollster. In particular, the Liberal Democrats have pushed hard for the policy in government. Raising the threshold to £10,000 was the party’s first pledge in its manifesto at the last general election. And now both the Conservatives and the Lib Dems have promised that if re-elected, they will remove those earning £12,500, roughly the amount earned by those on the minimum wage, out of paying income tax altogether.
Although that is a powerful electoral message, boosting the allowance further will no longer benefit the lowest earners. Most of the latest giveaway will go to the richest 50% of families, or to groups such as pensioners who do not work (although the richest few percent of earners do not receive an allowance). And last year, the poorest 17% of workers paid no income tax anyway. In short, it is a middle-class tax cut dressed up in working-class clothes.
And it is a policy that now makes less economic sense than ever. It has contributed to the sluggish growth in tax receipts, as it has shrunk the number of people who contribute to the Treasury. It also gives a greater subsidy to the self-employed, who pay less in national insurance contributions (NICs), which skews incentives in the labour market.
Using the money to raise the threshold for paying NICs would be more sensible. As employers have to pay a proportion of these, reducing the burden would encourage them to create more jobs. Mr Osborne was considering plans to merge the two systems as recently as last summer. Practical difficulties and the general election due in May have meant that efforts to reform the NICs system have been kicked into the long grass. Sadly, income-tax cuts make for a more powerful electoral message.
