Matt T

Tory tax cuts

Of their £4bn tax ‘cut’ the Conservatives have so far spent £1.7bn on making pensioners a little better off, and thus have £2.3bn left to play with. We await with baited breath the details, but one suggestion that has been floated in the press has been to increase the threshold at which higher-rate taxation is paid.

This threshold for the new tax year 2004/2005 will be £37,295. This threshold has fallen as a % of average earnings essentially since it was introduced in 1988, and from 161% of average earnings in 96-1997 to 143 in 2003-2004, increasing the number of people paying the higher-rate from 1.7m in 1990, to 2.1m in 1997 and 3.3m today. Unless it is increased the Institute of Fiscal Studies estimates that it will fall to 129% of average earnings by 2009, where perhaps 4m people will be paying it.

This has exercised the Conservative Party who of course draw a lot of their support from people who earn between £30,000 and £50,000 per year. Hence their interest in doing something about it.

So what could the Conservatives do with their £2.3bn? A simple calculation suggests that if there are 3.3m higher rate taxpayers then each could get about £750. This would be equivalent to increasing the band by (40%-22%)*£750 = £3,888, i.e. making it around £41,000.

In fact this calculation rather overestimates the cost. There are many higher-rate taxpayers who don’t earn £3,888 more than the higher-rate threshold, so they wouldn’t benefit by as much as £750. Scaling up an IFS estimate of 2001 suggests the band could be increased by about £4,500.

This would give taxpayers who earn £41,795 a boost of £810 each, and progressively less for those who earn between £37,295 and £41,795. Those who earn below £37,295 would get nothing.

Here is perhaps the political problem. Over 70% of households would gain nothing. The top 10% would gain the most, about 0.8% of income, whilst the next decile would gain about 0.3% and the third very little (these figures come from the IFS’s 2001 analysis and the numbers would be slightly higher , but the distribution would be the same).

The reason is that most people and households earn nowhere near this much. Roughly speaking for households to be in the richest 10% they need to earn about £24,000 p.a if they are a one person household, £40,000 p.a if they are a two-person household, and about £57,000 if they are a couple with two children (this is not, obviously, because the latter earn more than a childless couple. It is because they require more income to be equivalently wealthy; ie the income has been equivalised). To be in the top half the figures are £12,000, £19,500, and about £28,500 (I’ve scaled them up for 2004). Here's the income distribution for individuals today (the red line shows someone who earns £30,000 a year.

The problem then politically is that you are really appealing to either people who already vote for you, or people who probably will never vote you on these grounds, because they vote for you for non-economic reasons.

At the opposite end a different option would be to forget higher-rate taxpayers altogether and stick to raising the personal allowances. But will these people ever vote Tory?

There are of course many in-between options. One would be to make the ceiling on national insurance contributions the same as the higher-rate tax threshold, and then increase both. This would stop the somewhat perverse movement in marginal rates, where it goes from 33p to 22p, then back up to 40p [I made a slight error here (see comments). It appears there is now no national insurance ceiling because there is a 1% rate that takes over and has no ceiling. A stealth-tax extroardinaire, given I didn't know it existed. So the marginal rate goes from 33p to 23p, then up to 40p. This doesn't change the suggestion, which would you would keep the 11p NI rate up to where the 40p band takes over].

posted by Matthew @ 3/30/2005 12:41:00 PM Comments: 0