Increasing the higher rate tax threshold does not help middle-income earners

By far the biggest gainers from an increase in the 40p threshold are families in the top income decile.

Lamontj

Tony Dolphin is chief economist at IPPR

On Newsnight last night former Conservative chancellor of the exchequer Lord Lamont called on George Osborne to use next week’s budget to increase the threshold at which people start to pay the 40p income tax rate.

He was backed by another former Conservative chancellor, Lord Lawson, who said in a Daily Telegraph interview that the number of people paying higher rate tax should be much closer to what it was in the 1980s.

The former chancellors – and John Redwood quoted in the Times – think the move is necessary to help ‘middle-income earners’.

The coalition has increased the starting point at which people pay income tax to £10,000, but to prevent higher rate taxpayers gaining more than basic rate tax payers from this move, it has also narrowed the basic rate tax band.

As a result, the income level at which people start to pay 40p has not gone up as fast as wages and there has been a big increase in the number of people paying the 40p rate. It is already over four million and expected soon to reach five million, compared to less than one and a half million at the end of the 1980s.

We have analysed the distributional impact of increasing the personal tax allowance by a further £500, to £10,500, and compared it with the effect of increasing the higher rate threshold by £2,500. Both policies cost around £2.5 billion in lost income tax.

Effect on disposable income of changes in tax allowances %

Family income graphj

By far the biggest gainers from an increase in the 40p threshold are families in the top income decile. Proportionately, they gain twice as much as those in the next highest decile, who in turn gain twice as much as those in the third highest.

Increasing the 40p threshold is not, therefore, a policy that helps ‘middle-income earners’.

Clearly, Lord Lamont, Lord Lawson and John Redwood have an inflated notion of the pay of a middle-income earner in the UK. According to the Office for National Statistics, the average amount a full-time employee was paid before tax each week in April 2013 was £517. This is the equivalent to £27,000 a year. The 40p threshold is £41,450 – more than 50 per cent higher.

Increases in the personal tax allowance are a better way of helping middle-income earners. Our analysis shows that the biggest gains – as a proportion of disposable income – are made by families in upper half of the income distribution (though those in the top decile do not do so well).

They do not, though, help low income families.

Although the coalition trumpets the number of people it has taken out of income tax altogether, our analysis shows families in the bottom two deciles barely gain at all from further increases in the personal tax allowance.

A better way to help many of this group would be to increase the starting point at which National Insurance contributions are paid.

5 Responses to “Increasing the higher rate tax threshold does not help middle-income earners”

  1. uglyfatbloke

    A genuinely useful and informative article. Cheers Tony.

  2. robertcp

    Some Tories just live on a different planet to the rest of us! Increasing the starting point for NI is clearly the best way to help the low paid and middle earners. I hope that Labour forgets about a 10p rate, which will just bring back bad memories.

  3. benyoudel

    We could start collecting taxes properly by having a flat tax rate across the whole of the EU so that google and facebook can’t hide in Ireland – this would mean that we wouldn’t have to go nit-picking at individuals for small amounts.

  4. benyoudel

    I agree that tax cuts are a good thing. However, with the conservatives, they offer endless tax cuts in return for endless cuts. Tax cuts should be a luxury, offered only when the government can afford it. We cannot afford even more tax cuts – especially when they areonly for the 1%.

  5. GO

    “A better way to help many of this group would be to increase the starting point at which National Insurance contributions are paid.”
    A better way, maybe, but surely still a very poor way? As with the rises in the personal allowance we’ve already seen, most people in the bottom decile or two would gain little or nothing because they pay little or none of the tax in question (since they’re pensioners, benefit claimants, or very low earners)?

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