Opinion: Fair taxes – radical and challenging Liberal Democrat plans

Stuart Adam and Mike Brewer of the Institute of Fiscal Studies argue, in their April ‘observations’ piece on Liberal Democrat tax cutting policies, that it is meaningless to make the claim that the poor pay more of their income in tax than the rich.

However, no sooner do they make this observation than they go on to confirm that official statistics show this is the case. No one, they explain, disputes the ONS data which shows that the poorest fifth of households paid 38.7% of their income in tax. Neither is there any dispute that this compares with a tax take of £25,926 or 34.9% from the richest fifth of households.

So what is the point that they are trying to make? The point they are trying to make seems simple but its ramifications, for individuals and households and for tax and benefit researchers, are far reaching and exceptionally difficult to calculate and communicate. The point is that the interaction of tax and benefit policies is exceptionally complex and subject to great change over time. In order to judge the final or net impact of public policies on the incomes of different individuals and households (and the changing relativities between them) it is necessary to estimate the ultimate outcome of packages of taxes and benefits in terms of the changing resources that individuals and households command over time.

A simple corollary of this – particularly significant when it comes to current policy debates – is: the proportion of a household’s income that goes in tax is full of meaning. I’m simply not prepared to believe that either Adam or Brewer dispute the idea that the choice between increasing National Insurance contributions and extending and/or increasing VAT, given the differential impact of those taxes on rich and poor households, is anything other than highly significant.

How is this relevant to the Liberal Democrats ‘fair taxes’ policy? Well Adam and Brewer’s ‘observations’, along with a piece by Tim Horton and Howard Reed entitled ‘Think Again Nick!’, have become part of the criticism directed against the party’s 2010 manifesto; a manifesto promising fairer taxes and committing the party to taking 3.6 million low earners and pensioners out of income tax.

The Liberal Democrat plan to raise the income tax threshold to £10,000 – a key party election pledge – will result in an income tax saving for the poorest AND for many others. The total cost of raising the threshold will be approximately £17 billion; about £1 billion of that (or 6% of the planned cut in income tax) will go directly to the poorest fifth of households. The Liberal Democrat claim that this is fair can be judged in many different ways. It should not be judged exclusively in terms of what happens to the incomes of individuals and households at the bottom of the income distribution. It is not a plan for the abolition of poverty. Liberal Democrats have not been so silly or so dishonest as to promise the elimination of child poverty over twenty years.

Fairness in tax is not simply a question of taking substantial numbers of low earners out of tax – though that is, from a Liberal Democrat perspective, a very important goal. Fairness has to do with changing the tax system in ways that make it fairer for millions of earners/tax payers, including the poorest. It also has to do with the opportunities that one reform creates for later reforms/reform strategies. This is something that Horton and Reed and, most disappointingly, Adam and Brewer of the IFS, appear to find it hard to understand and fail utterly to address in their assessments of Liberal Democrat policy.

In order to properly assess the contribution to fairness of the Liberal Democrat manifesto promise to raise the starting point for income tax it is vital to consider all the factors that will determine its overall impact on individuals and households. It is necessary to carefully consider and factor in how it will be paid for. Where will the costs of the tax increases, which are an integral part of the Liberal Democrat tax cutting plan, fall?

The tax measures designed to fund the increase in the income tax threshold include: (a) restricting pension tax relief to the basic rate of tax, (b) aligning capital gains tax and income tax rates (an important measure which will contribute to the goal of limiting opportunities for tax avoidance in future), (c) a first instalment of measures to crack down on tax avoidance (currently estimated at over £40 billion annually), which will raise almost £5billion; and, (d) a mansion tax on properties valued at over £2 million. There are also plans to generate additional government revenue from taxing emissions, specifically a reformed tax on air travel.

Party supporters as well as critics need to understand that many of those who can expect to benefit from the £700 cut in their income tax will also be making offsetting contributions through the tax system so that the package can produce, as it is intended to, substantial net benefits for some of the poorest income earners. More intelligent and fairly distributed taxes on air travel, capital gains and on income used by the best off to make pension contributions (which have been treated exceptionally favourably in the past), are part of strategy to make the UK tax system more equitable as well as more transparent.

How have Horton (Research Director at the Fabian Society) and Reed (Director of Landman Economics) taken the critical tax raising/funding side of the Liberal Democrat tax cutting proposition into account? In their own words: “The aim of this report is not to try and evaluate this whole set of tax proposals”. They claim that “at certain points” they attempt an overall assessment, by referring to such things as its “progressivity and ‘fairness’”, but, as the cover illustration of ‘Think Again Nick!’ (a picture of Nick Clegg with hand on head) makes clear, what they have produced is first and foremost a party political piece – Fabian propaganda (rather than politically neutral analysis).

Readers, as Horton and Reed explain, will just have to wait to find out why, “when you take the whole of tax and spending into account those on low incomes would…be net losers from a revenue-neutral tax cut that lifted them out of tax”. The detail of their full analysis will only be revealed when their ‘forthcoming’ publication on the subject comes out. And, in their concluding commentary – a few bullet points long – in a publication that is titled an appeal to Liberal Democrats to think again, they identify, as the two “most enthusiastic public cheerleaders” for the Liberal Democrats tax plans: “Norman Tebbit and right wing blogger Paul Staines”.

Stuart Adam and Mike Brewer of the IFS have promised a fuller treatment of Liberal Democrat tax plans – after the publication of the Liberal Democrat Manifesto. It is most unlikely that their fuller treatment will include a picture of Nick Clegg with hand on head, or references to those notable authorities on Liberal Democrat thought and policy, Tebbit and Staines.

As a subscriber to the IFS I certainly expect Adam and Brewer’s future observations to reflect the fact that studies of the redistributive impact of tax and benefit changes necessarily rely on ‘figures [that can only give us] a snapshot’. In reality (as they acknowledge), ‘much low income is temporary’ and the circumstances and living standards of people at the bottom of the income distribution are subject to, often substantial, change. Understanding the dynamics of poverty, inequality and opportunity is very important to Liberal Democrats. It is also critical to the formulation and evaluation of proposals for a more equitable taxation and benefit system and a fairer society. A balanced (and fuller) IFS assessment – of the party’s tax plans – like a balanced parliament – will be most welcome.

The Liberal Democrats are trying to develop and implement policies which do not treat the poor as a race apart but help to establish a pattern of taxes that more fairly distributes society’s membership costs, encourages all those who can to take up paid employment (and assist them in obtaining a fair reward for doing so), as well as advancing the goals of tax and benefit simplification. The Liberal Democrats ‘fair taxes’ policy is a good start. No sensible person, certainly no Liberal Democrat, should deny that there is still a mighty long way to go.

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