Clegg’s tax cut doesn’t tackle low pay

Tackling low pay is a good thing for the government to be doing. Unfortunately, the coalition’s flagship policy doesn’t actually do that.

Spencer Thompson is economic analyst at IPPR

Every political party wants to help the low-paid, and for good reason. With rampant increases in the cost of living and an unforgiving labour market that offers little chance of progression, low-paid workers have been some of the hardest hit since the recession.

Where the parties differ is in how to tackle the issue. So far, the coalition’s strategy for low pay has been to rapidly increase the value of the personal tax allowance (PTA) – the amount of income an individual can earn before they start paying income tax.

This strategy has been spearheaded by the Liberal Democrats. By next April, they will have achieved their ambition for this parliament of reaching a £10,000 PTA.

Last Sunday, Nick Clegg announced that he wanted to go further, moving a £10,500 PTA in 2015/16.

The Clegg announcement claimed that increasing the personal tax allowance by £500 will put £100 in the pockets of taxpayers. In fact, since the PTA is index-linked to inflation, we would expect it to go up between 2014/15 and 2015/16 by around £250 anyway, whichever party is holding the purse strings. This means the discretionary rise in the PTA is actually only worth around £50 to tax payers.

There are other problems with this approach, especially the fact that it doesn’t help the lowest-paid. Moving from £10,000 to £10,500 has no impact on the 5m or so low-paid workers who are already earning less than £10,000. In fact, the group that stands to gain the most is the highest paid.

This makes sense if you think about it – they pay more in income tax, therefore an income tax cut is likely to help them more as well. The chart below shows how the benefits of a £10,500 PTA vary across the income distribution.

The picture is clear – the £50 this puts in the pockets of taxpayers on average is more like £80 for the richest 20 per cent, and substantially less for those in the bottom two-fifths of the income distribution.

If you insist on implementing a tax cut to help low-paid workers, then focus on National Insurance, which people start to pay after earning £8,000 a year, rather than income tax which kicks in later. This point was well put by the Resolution Foundation’s Gavin Kelly in today’s Independent.

Average change in annual income of a £10,500 versus an inflation-linked PTA by family income decile (2013/14 prices)

Clegg tax

Finally, increases in the PTA are expensive. The Lib Dems put the cost of the £10,500 PTA at around £1bn. My calculations suggest it would be slightly higher at around £1.3bn.

Whoever is right, PTA rises in the context of deficit reduction, with a billion put towards this policy that doesn’t help the low-paid, means cuts in public services need to be found elsewhere. And if they continue with the policy into the next parliament the bill will just keep adding up.

Tackling low pay is unambiguously a good thing for the government to be doing. Unfortunately, the coalition’s flagship policy in this area doesn’t actually do that, and is enormously expensive.

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