Opinion: Making allowances – 12 conclusions about the Personal Allowance policy

CentreForum today published ‘Making allowances’ – a paper all about the Lib Dems’ flagship policy of raising the income tax Personal Allowance. Here are some of my conclusions – some obvious, some more obscure – to help inform future tax cuts.

1) The costs are huge. The coalition’s Personal Allowance increases have cost £11bn, and the Lib Dems’ minimum wage tax target would cost at least the same again. With this combined total, we could (roughly) reduce VAT to 15%; scrap council tax or business rates; easily deliver quality universal childcare; or pay for a project like HS2 every year. We need to talk much more about these opportunity costs.

2) Be careful about funding. Which £11bn of spending cuts, borrowing or tax increases funded the higher allowance? The coalition’s rules likely mean that all tax cuts are balanced by tax increases but, still, one could say it was the £13bn VAT increase that funded income tax cuts (a regressive combination). High costs might also interfere with fiscal plans and coalition discussions. Could a LibLab coalition find and deliver over £11bn of tax increases for the new Lib Dem policy as well as more for deficit reduction? Or, if this policy is a ‘red line’ but not the way in which it’s funded, can we guarantee it won’t be funded through welfare cuts or similar?

3) Most of the money doesn’t go to low earners. Allowance increases are much more pro-poor than cutting the basic rate, but over three quarters of the £11bn cost has nonetheless gone to the richer 50% of families. If the main goal is to help near-minimum wage workers and take people out of [one sort of] tax, the policy’s cost is currently almost entirely ‘deadweight’ of helping the better off.

4) Does any of the money go to poorer families? What’s more, under Universal Credit, 65% of any tax cut will be withdrawn from most poorer households. The party should clarify whether it would recycle that money back to these families, or whether extra cash for poorer households is somehow not the point.

5) Have allowance increases limited pay increases, and boosted employment? Tax cuts can be passed between employers and employees, and it may be that propping up disposable incomes with employee tax cuts has allowed employers to increase wages by less. The flipside is that such tax cuts might sometimes mean higher employment through lower employer costs. This is on top of positive effects on work incentives: marginal rates are reduced for some low earners (even with Universal Credit), and the incentive to rejoin or remain in the labour force is boosted.

6) Taking people out of auto enrolment and childcare support. The Personal Allowance is also the threshold for pension auto enrolment and for extra Universal Credit childcare support. The latter condition at least could easily be changed, but for now allowance increases will make some families worse off, and take millions more out of pension saving. Some tax breaks are also currently linked to the allowance.

7) National Insurance (NI) should be the priority. Why campaign for a £12,500 income tax allowance when some NI starts at £5,885? Employee NI alone is more of a burden than income tax for everyone earning under £13,000 (£52,000 if we include employer NI). 1.5 million earners would benefit from a NI cut but not at all from further Personal Allowance increases, with many more getting only a little from the latter. A NI cut of the same cost would be twice as valuable for the poorest 20% of households; while income tax cuts increase the bias towards rent etc. over labour income. Employer NI cuts shouldn’t be excluded either, and might allow for a higher minimum wage. Aligning the NI thresholds with each other and with the £10,000 Personal Allowance would bring real tax simplification benefits too (and NI cuts do not affect benefit eligibility).

8) The tax system is complicated! Surprisingly, if the Personal Allowance is raised to £12,500, those earning £125,000 or more will get a £500 tax increase (even before any changes to the higher rate threshold): an accident caused by the complex withdrawal of the Personal Allowance (a 60p tax band made bigger by allowance increases). Reducing the higher rate threshold is also complicated: while it can cancel out income tax cuts, at the same time it gives a NI cut to most (but not all) higher earners.

9) Increase the basic rate to target tax cuts on low earners. Better than reducing the higher rate threshold would be to increase the basic rate: not leaving anyone worse off but tapering away the tax cut. Higher rate payers would get zero overall, low earners the full amount and other basic rate payers something in between based on their income. If Lib Dems were prepared to increase the basic rate to ~23%, they could for the same cost raise the Personal Allowance to £14,600 instead of £12,338, further helping those earning less than £28,000 – surely the intended targets – by giving richer taxpayers a smaller tax cut. Or, such targeting could be used to reduce the cost. That said, larger rate increases – especially for NI – would be a fair way to entirely fund allowance increases. Even the Tory peer who originally proposed a £10,000 threshold (back in 2001) wanted to fund it through higher rates.

10) It’s a £480 income tax cut, not £705. The Personal Allowance would have risen with inflation even without the Lib Dems. Similarly, the proposed £100 tax cut for 2015-16 would really be only £50-60 (and seems mainly an attempt to avoid a purely inflationary increase – that the party couldn’t take credit for – complicating its message).

11) The minimum wage is not a good formal target. It is not a measure of living standards, nor even an annual figure. We have already taken the majority of minimum wage workers – most of whom are part-time – out of income tax: it’s fairly arbitrary whether an annual equivalent should be 35, 37.5 or 40 hours per week rather than the current 30 (plus, income tax is only one of many taxes). Another challenge is that the tax year is from April while the NMW changes in October. It’s also odd that we might adopt the NMW as a link just as it is judged to be in need of reform. While it’s fallen in real terms recently (which would have meant a tax increase under an allowance link) it will likely increase in coming years (if it stays in its current form) further increasing the cost. But would ministers still accept – let alone push for – a higher NMW if every 10p increase meant finding another £1bn for our tax cut? In short, I don’t see how an hourly, expert-recommended wage, limited to avoid unemployment, could remain linked to an annual, political, tax level: they are both too important.

12) We could take the poverty line out of tax. My report considers links to the Living Wage and median incomes, but concludes that the poverty line is the most compelling at present. This differs between family types but one could say, given our individual-based tax system, that childless adults should not be pushed below the poverty line by direct taxation. The relative poverty line has been taken out of income tax – but not NI – thanks to coalition policy. The absolute poverty line for a single adult is £10,050 in 2014-15 (and ~£10,350 the year after). Clegg’s small “worker’s bonus” (plus relinking to RPI) could take this out of income tax, but a large NI bill would remain.

All in all, there are good reasons to be sceptical of any allowance increases – on all sides of the party. It may be unhealthy to let it dominate a decade or more of the party’s policy development, budget commitments (as it has and will) or message (“vote for us and we’ll give you £500”).

But there are also ways in which the policy can be improved. Choose National Insurance; do more to target the low paid; and take care with funding, interactions with other policies, and the choice of target. Read the full report for more.

* Adam Corlett is an economic analyst and Lib Dem member

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This entry was posted in Op-eds.


  • Eddie Sammon 16th Jan '14 - 12:54pm

    Thanks for the article. I just want to make a correction that NI starts to be paid at £7,748, not £5,668. The lower threshold is for state pension entitlement, so we can increase the higher threshold and keep the lower one as it is to protect pensions :).

    On the bigger point: I broadly agree that NI cuts are better than income tax ones at this moment in time.

  • Could we not raise the basic level of tax, and then lower the level at which upper level tax comes in, so as to exactly compensate?

  • Peter Davies 16th Jan '14 - 1:24pm

    The combination of standard VAT rate increase and personal allowance rise is not regressive. Benefits are linked to CPI which compensates the poor for VAT increases while the rich (who spend more than 6 times as much on VAT standard rated goods as they gain from the personal allowance change) pay more. You are right that NI changes would do more but what would really benefit the poor is to allow those who don’t reach the person allowance to claim back the value of the unused part.

  • I agree with the comments about NI. Raising the NI threshold to £10,000 helps the poorest more than raising the income tax threshold to £12,500. There’s probably a something in the idea of increasing the tax threshold in exchange for putting up the basic rate of tax. This would benefit the low paid more than those on middle incomes, whilst not being so expensive.

  • Mick Taylor 16th Jan '14 - 3:00pm

    Raising the NI threshold is great for those who actually pay it.

    People who don’t, including pensioners (declare my interest) would gain nothing at all.

    Incidentally, the higher band threshold for 40% taxpayers has gone DOWN to take account of the basic threshold rise.

  • Adam Corlett 16th Jan '14 - 3:40pm

    Thanks for the comments, all!

    @Ed, you are right but so was I: “some” NI – for the self-employed – does start at that even lower level. See the article linked to there for a description of how easy that would be to solve.

    @Peter, I disagree on VAT. Firstly, not all low/middle income households are on benefits, and for others those benefits are not necessarily sufficient to cover all their VATable spending. It also ignores the political aspect. As I understand it, the VAT rise did push up benefits but then the coalition complained that benefits had risen faster than pay and so cut them!

    Your second point is something I’ve been interested in too. Allowing unused PA to be used against, say, council tax (or National Insurance) would be very progressive. It might not be workable but it’s worth looking into (a fairer alternative to the married couples’ transferable allowance). There are interesting ideas about recreating the PA as more of a tax credit, or a citizen’s income – both ideas the LDs have supported in the past.

  • Andrew Colman 16th Jan '14 - 5:01pm

    The raising of tax thresholds is one of the great achievements of this government.

    Yes , one may be able to target money more carefully, but this involves government deciding who and who is not worthy. Groups with the most sympathy and clout get the most eg single mums, parents using childcare when many get nothing eg a single male over 25 with no parental responsibilities. Its a form of paternal social engineering where government thinks it knows best.

    At last we have a change and the higher thresholds are starting to remove one of the great injustices of our society, the poverty trap. I hope the process will continue and the poverty trap got rid off .

  • Peter Davies 16th Jan '14 - 7:02pm

    @George That change did not come in until after the VAT increase had worked through so it isn’t part of the package that Adam thought was regressive. There were indeed some losers among the poor (mainly those ineligible for benefit but not earning enough to pay but there are almost no winners among high earners.

  • Peter Davies 16th Jan '14 - 7:06pm

    @Adam Yes. My idea has exactly the same effect as citizens’ income. It’s just a different way of explaining it.

  • @Peter, I like your idea of allowing people to claim back the value of the unused part of the personal allowance. In fact I would be tempted to see if it were possible to go further and make it equal to the living wage. The art would be to ensure the earned income always counted for more than the credit from the unused allowance.

    However, I suggest that what ever the changes, they should be fully integrated into the tax system and not be a separate system and subject to all the rigmarole that surrounds the current tax credit and earnings related benefits; a UK taxpayer should only need to complete one set of forms to HMRC every year.

  • Eddie Sammon 17th Jan '14 - 3:20am

    Apologies Adam, I forgot about the Class 2 Small Earnings Exception. It looks to me it starts at £5,725, which is slightly higher than the LEL, but much closer to your figure than mine and most importantly you’ve got all the correct figures in the table in the report!

    I agree with raising NI thresholds to the personal allowance, but I am unsure of funding it by increasing NI rates elsewhere. I think there is room to do this for the rich, but I think the middle class pay too much tax as it is.

    Thanks, I’ve skimmed through the report twice and it looks like a good piece of work. Well done on getting it published elsewhere (I seen it in the New Statesman too).

  • Toby Fenwick 17th Jan '14 - 10:00am

    @Mick Taylor: the obvious point would be to have pensioners pay NI.

    Adam: a great paper-well done.

  • Matt (Bristol) 17th Jan '14 - 11:11am

    @ Toby Fenwick – if pensioners pay NI, what is NI ‘for’? It then becomes much closer to a non-income based universal basic per-capita charge for existing.

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