Forget about what the BBC, the Government or the Tories say about the impact of the changes to personal taxation and benefits announced by Gordon Brown today. Here is what it really means for people of working age (comparing the current system with the system as it will be in 2009, according to Gordon's announcements, taking 2009 because many of the announcements are delayed or staged).
- Those earning between around £5,000 and £18,000 p.a. get to keep less of their wages than before.
- Those earning over £18,000 keep more of their wages, with the greatest benefit (proportionately) going to those being paid in the £40,000s.
- Couples with one principal wage-earner continue to pay more tax than two-income couples on the same combined household income, thanks to his rejection of any form of joint or transferrable allowance.
- The negative impact on low-earners is to be compensated mostly through increases in the threshold for withdrawal of Working Tax Credits (WTC) and, for those with children, increasing the level of Child Benefit for the first child and of the child element of the Child Tax Credit. Those with one or two children will be best-insulated by these measures from the effects of the changes to income tax. Those on low incomes with many or no children will be the worst hit.
- To avoid these increases dragging too many more people into the means-tested benefits bureaucracy, the withdrawal rate for WTC has been increased to 39%. Because losing benefits has the same impact as paying more tax on a household's net income, this has further increased the effective marginal rates of taxation on poorer households. In some cases, marginal rates of taxation are now approaching 100% - in other words, you barely keep a few pennies of every extra pound that you earn. Marginal rates of taxation determine the incentive for people to work harder, longer or smarter to earn more money, so increases in marginal rates act as a disincentive to work. Gordon announced this change as "further strengthening the incentives to work for families with children and low-income working households". The precise opposite is the case. The disingenuity of this claim marks Gordon as either a knave or a fool.
The truth is probably that Gordon cannot now abandon his reliance on ever-more generous but targeted benefits, with the accompanying means-testing, withdrawal rates and high marginal rates of taxation, without admitting he got it wrong. Gordon's problem is that more and more people are realising that his micro-managing approach is not just bureaucratic, expensive and inefficient, but downright cruel to those who would like to contribute more to their own household income but who are discouraged from doing so by the magnitude of their loss of benefits if they did. And counterproductive for the rest of us.
It is hopelessly optimistic to think that he will have an epiphany and see the error of his ways, so Gordon is relying on the poor voting tribally with Labour regardless of his penalisation of them. If people vote according to their own short-sighted self-interest at the next election, we could end up in the counter-intuitive position of Labour being the party of the rich and the Conservatives being the party of the poor. What a pity we can't have a prudent party that treats rich and poor the same.
The scale of the gains for the rich winners greatly exceeds the scale of the losses for the poor losers, though those losses may be more keenly felt than the gains will be appreciated. Given the significant increases in health and education spending, the rough balance of increases and reductions in the spending on other departments, and the reduction in the headline rate of corporation tax, this is not the balanced budget that he claimed. It is improbable that deficits and government borrowing will be as low as claimed. Allowing the public to think that times are better than they really are will result in less caution in spending and saving than would be advisable given the economic fundamentals. It all adds up to further upwards pressure on interest rates. It is very likely that what Gordon has given, the banks (and indeed the central bank) will take away. Not that Gordon cares, because he will get the credit for increasing the net household income of homeowners without taking the blame for the increases in the cost of living that result from his failure to control expenditure and balance the budget. And even if the Governor of the Bank of England has to write the dreaded letter explaining why inflation is out of control, it is very likely that Gordon will no longer be the Chancellor to whom the letter is addressed. As John Stepek of MoneyWeek puts it, it looks like Gordon is "doing a Greenspan". But will people realise it, and punish him and the Labour Party for it? Is there a credible alternative?
Comments
Effect of tax changes
Here is a rough plot of the effect of the changes to income tax and national insurance announced today. This does not include the effect of benefit changes, as the impacts of targeted benefits are much harder to plot (being dependent on household rather than personal income and circumstances).
As you can see, the main benefit is felt by those on upper-middle or higher incomes. The benefit is greater as a proportion of gross income for upper-middle-income (£40-50k) than higher-income earners, although the absolute value is similar for the whole range. The disadvantage to lower-income earners is not visible at this scale, but does exist, and would signify to those for whom every penny counts. It is also clear from this graph that there is a net benefit overall. There will be some tax-revenue benefit from moving middle-income earners in the right direction along the Laffer Curve, but as the majority of taxpayers (those earning under £40,000 p.a.) see only small gains from the trade-off between the reduction in the basic rate and the loss of the starter rate, this is likely to result in an additional cost to the Treasury.
Social Engineering
For this to stop the notion that it is acceptable for the government to engage in social engineering needs to be abandoned. If people want their politicians to do the right thing for "the average family" or "couples" or whatever the favoured group-of-the-day is, this kind of tweaking the numbers for effect is what they can expect.
If we have to have tax at all, it should be a flat rate of income tax and that's it. Then it will be transparent and obvious to all what the tax rate is, and there will be no favoured groups and no lies for chancellors to hide behind.
Having the government play around with marginal economic incentives like this to achieve some supposed aim (e.g. encourage people on low incomes to work harder) is just another way for it to pick losers.
The state has no business in people's homes
Exactly Rob. For example, one of the features of a flat tax that is rarely mentioned is that it reduces the imbalance in tax-treatment between families with a single earner on a decent wage and families on an equivalent household income divided between two lower earners. Differential rates of tax applied on a per-person, rather than per-household basis, mean that single-earner households suffer not only from having only one allowance to deduct from the income that is taxable, but also from the fact that the level of tax applied is likely to be higher.
To really equalise it, you could have a transferrable allowance, like the Tories proposed, but that introduces additional bureaucracy for company wages departments and social-security offices to keep track not only of what each individual earns, but of their relationship status and what their partner earns. What would be better, along with the Flat Tax, would be to do away with tax allowances and most welfare measures, and replace them with a Basic Income. That way, it would be irrelevant whether two people lived together or separately, married or unmarried, with or without kids - they would be treated the same by the state. You would have an infinitely-variable progressive effective tax-rate with minimal bureaucracy and no picking of social winners and losers, and no artificial incentives to follow one or other lifestyle choice. See quotes from Shaun Bailey, author of No Man's Land, in the latest publication from the IEA by Patricia Morgan on The War Between the State and the Family for a good example of that effect. Patricia argues for positive promotion of marriage through the tax and benefits structure, but simply removing the bias against co-habiting couples (whether married or living together) would be a good start, and in my opinion should be sufficient.
Erratum
Actually, as has been pointed out to me at Burning Our Money, I have got my maths wrong for higher earners. The benefit to those earning over £40k is very small. The greatest benefit is to those earning between £20k and £36k. The downside to those between £5k and £18k is correct. There is much less difference than shown above. The overall cost to the Treasury of the changes to NI and IT is negative (i.e. the Government is taking more of our wages), but the net effect of all changes to personal income, including tax credits, still constitutes a significant hand-out, of around £2bn in 2008-9 and £2.5bn in 2009-10. This does not alter my conclusion that the budget is inflationary, because of expansive spending commitments that are likely to require increased borrowing.