Since Nick Clegg gave his recent speech about raising the threshold for paying income tax there has been heated and highly publicised political and social debate about how best to help poor families in the UK – culminating in last week’s Commons vote on the benefits cap.
The Deputy Prime Minister has for many months spoken of his firm commitment to what he called the “fundamental need for reform” of the UK tax system and the “rebalancing” that he says needs to take place. This intervention won him praise from within his own party and indeed from many outside it, including among economic commentators who share his concerns about the oppressive nature of the current tax regime and its failure to put work at its heart.
We all remember the outrage caused by David Cameron when he revealed that the current welfare system greets many people going into low paid work from benefits with a marginal tax rate of up to 96 per cent. He called this a “huge disincentive to work”- and endorsed plans to tackle a benefits system that was acutely trapping people on benefits. It is in this context that we should see Clegg’s good intentions. But while his rhetoric might sound encouraging, the proposed policy solution fails to address the problems with our current tax system.
Although the Deputy Prime Minister’s desire to take more people out of tax is driven by his desire to help struggling families within the “squeezed middle” – the main mechanism being promoted for doing this is lifting the personal income tax threshold to £10,000. So for the first £10,000 you earn you would pay no income tax. Whilst initially this might sound good, the reality is that this proposal is not progressive for families. Indeed, as a recent report for CARE indicates, it has a disproportionately positive benefit for richer members of our society in the top half of the income distribution.
An alternative policy of introducing a transferable tax allowance for married couples is, as the report demonstrates, genuinely progressive in its design, benefitting poorer families disproportionately in comparison to their better-off counterparts. In addition, a transferable tax allowance would begin to alter the balance in our system from one which is almost wholly based on the individual to one more sensitive to family responsibility.
Despite all the positive and progressive effects of the transferrable allowance, there has been no mention of this by the Liberal Democrats in the debate around this issue. Needless to say, there was also no discussion of this measure in Nick Clegg’s address last Thursday.
The truth is that ‘pound for pound’, money spent on providing transferable allowances for married couples is a far more progressive means – both in terms of recognising family responsibility and helping those in the lower half of the income distribution – of spending taxpayers’ money than investing it in increasing the personal income tax allowance.
Furthermore, if Mr Clegg and his party want a new tax and benefits system to have work at its heart then he’ll need to address the cripplingly high marginal effective tax rates (METR) present under the current system. If the Liberal Democrats really want work to pay, then it is imperative that they analyse how much income a family is left with as they rise up the income scale and are subjected to tax increases and benefits cuts.
Indeed, despite another flagship Coalition policy, the Universal Credit, having a positive effect of lowering the METR for some families, many families will still be left facing METRs of 76%. So for every £1 earned whilst in work, families will see only 24p coming into the home: perhaps the Lib Dems should look at how this could be improved further.
All in all, given the individualism of our tax system, with its lack of sensitivity to family responsibility, and the simultaneous shortcomings of our welfare system, with its failure to adequately incentivise work, it was good to see Clegg trying to kick start the debate on reforming our broken tax system.
My hope is that this debate will ultimately encourage the development of a system that both properly provides for those in need and rewards work as well. Disappointingly, however, the Lib Dem flagship tax policy of increasing the personal income tax threshold would have the highly regressive effect of helping better off families disproportionately in comparison to poorer ones.
The progressive transferrable tax allowance on the other hand would do the opposite. It would also begin to reform our system in the right way, laying down the foundations toward move to a system that recognises not just individual income but also family responsibilities.
This article was originally published on ConservativeHome in February 2012 here.
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