Millions of the poorest households gain nothing from increases in the personal tax allowance.
There is a competition at the top of the coalition as to who can claim the most credit for raising the income tax threshold to £10,000.
The Tories cite “a tax cut for 24 million hardworking people” as one of the coalition’s signal achievements; and according to today’s Times, David Cameron’s next manifesto is likely to promise to raise the personal allowance threshold again to £12,500.
Nick Clegg is also trying to expand what he (accurately) considers a flagship Lib Dem policy, and wants to raise the threshold to £10,500 from 2015.
The coalition and their cheerleaders in the press are predictably keen on tax cuts, and are painting the raising of the tax threshold as progressive and a boon for feted ‘hardworking people’.
As the Mail puts it,
Millions of Britain’s hard-pressed taxpayers will find themselves up to £705 better off after the coalition today delivered on its flagship tax cut a year early.
There are several problems with simply raising the tax threshold, however.
Firstly, the greatest percentage change in net income from the personal tax free allowance of £10,000 is seen by those on the upper end of the income scale – not, as is often claimed, low earners.
The important line is the purple one, which accounts for the policy as proposed by George Osborne. The blue line represents the Liberal Democrat’s original proposal which Osborne has adopted without the corresponding adjustment of the higher rate threshold.
This more recent graph from the Institute for Fiscal studies makes the same point.
Analysis carried out for Left Foot Forward in 2010 also found that some three million households in the poorest quarter of the household income distribution would gain nothing from raising the personal allowance to £10,000.
Increasing the personal allowance also serves to increase the gap between the bottom and the middle, resulting in low income households falling behind relative to the middle.
The reason it benefits those on the right of the graph more than it does those on the left is because a raise in the personal tax allowance cuts income tax for everyone that earns enough to pay it since all benefit from a higher tax threshold. Those who don’t pay income tax – low earners, the disabled, those in retirement, the unemployed – gain nothing.
It isn’t only those on the left who have in the past expressed concern about increasing the personal allowance. Here is David Willetts in 2005 (page five):
When I asked the Treasury last year how much it would cost to raise the personal tax allowance to £10,000, it estimated the cost at £30 billion. Of this, only about £2 billion was spent on people who are taken out of tax altogether and it is worth least to people on low incomes who don’t get the full value of the policy…My conclusion is that we should both reform our tax system and help poor people. But these are different problems requiring different solutions (The Times, 23 June 2005).