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A £10,000 personal allowance: who would benefit, and would it boost the economy?

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Authors: James Browne

Despite the planned net fiscal tightening of £123bn per year by 2016-17, the coalition government has sought to cut income tax for low-income individuals by increasing the income tax personal allowance to £10,000 by 2015-16. Significant increases to this allowance – the amount of income that is not subject to income tax – have already been implemented or announced, at a combined cost to the government of nearly £5 billion per year: it increased by £1,000 in 2011-12 to £7,475, and it will increase by a further £630 in 2012-13 to £8,105 (£700 and £210 more than it would have gone up by under default indexation rules in those years respectively).

How much more would it cost the government to meet its target of reaching a £10,000 personal allowance by 2015-16? Normal price indexation of the personal allowance (the assumption underlying the Office for Budget Responsibility’s forecasts for the public finances) would mean that it would reach £8,885 in 2015-16 without any discretionary policy changes given current inflation forecasts. Compared to this baseline of £8,885, a personal allowance of £10,000 in 2015-16 would mean that tax revenues were £5.3 billion lower in that year. To reach that ambition earlier, as several Liberal Democrat and Conservative politicians have recently advocated, would reduce income tax revenues by more than this, as shown in the table below:

Year £10,000 personal allowance introduced Annual cost to the Exchequer
2012-13 £8.9bn
2013-14 £7.7bn
2014-15 £6.5bn
2015-16 £5.3bn

Note: Costs are for the year in question: if the personal allowance were subsequently increased in line with inflation (the default indexation policy), the cost would remain roughly the same. Alternatively, if the personal allowance were frozen at £10,000, the cost would fall as shown in the table.

Source: Author’s calculations using the IFS tax and benefit microsimulation model, TAXBEN, run on uprated data from the 2009-10 Family Resources Survey.

 

These figures all assume that the threshold at which the higher 40p rate of income tax starts to be applied is unaffected. This means that higher-rate taxpayers get the same benefit from the higher personal allowance as those who remain basic-rate taxpayers. If the government wanted to lower the cost of achieving a £10,000 personal allowance, it could prevent higher-rate taxpayers from benefiting at all by reducing the threshold at which the 40p rate starts to be applied: this would reduce the cost to the Exchequer from £5.3 billion to £3.3 billion in 2015-16. This approach would lead to a significant increase, of around 600,000 in the number of higher-rate taxpayers. Under current policy proposals this would also mean that about 200,000 more families with children would lose their Child Benefit because an adult in that family would become a higher rate taxpayer after the lowering of the higher rate threshold (these Child Benefit savings would account for about £300 million of the reduced cost to government of meeting its £10,000 target in this way).

The gain from increasing the personal allowance to £10,000 in 2012-13 (without changing the higher rate income tax threshold) would be £379 a year to each individual taxpayer aged under 65 with an annual income between £10,000 and £116,210. There are three groups of individuals who would not benefit: those aged 65 or over, who already have tax allowances exceeding £10,000 (other than those with incomes above around £29,000 who see their allowance reduced to the level of the allowance for those aged under 65); those who do not have incomes high enough to pay income tax anyway (more than a third of the adult population); and those who have the personal allowance fully withdrawn as their income exceeds £120,000. Those with incomes between £8,105 and £10,000 would see their income tax liabilities fall from less than £379 to zero. A gain of £379 is of course larger as a percentage of income to a low-income individual than someone with a higher income, although it is important to remember that the poorest third of adults do not benefit at all because their incomes are already below the personal allowance.

But if we examine the distributional impact at the family level (which is normal for this sort of analysis, since we would expect at least some degree of income sharing within families) we get a different pattern to the one we might expect. This arises because two-earner couples, who tend to have higher family incomes, can benefit twice over from the increase in the personal allowance because both members of the couple would see their income tax liabilities fall by £379, meaning that they would gain £758 in total. Thus, the highest average cash gain occurs in the second-richest tenth of the income distribution (some of the richest tenth would not benefit because of the withdrawal of the personal allowance above £100,000, lowering the average gain for this group). As a percentage of income, the gain is roughly the same from just below the middle to just below the top of the income distribution, with the bottom and the very top gaining by less than this.

To summarise, the common assertion that increasing the personal allowance is progressive is true if one considers the gains across individual income taxpayers. It is not true if one considers the gains across all families as relatively few of the poorest families contain a taxpayer and two-earner couples gain twice as much in cash terms as one-earner families.

Distributional impact of increasing personal allowance to £10,000 in 2012-13, by income decile group

Income deciles

Notes: Income decile groups are derived by dividing all families into 10 equally-sized groups according to income adjusted for household size using the McClements equivalence scale. Decile group 1 contains the poorest tenth of the population, decile group 2 the second poorest, and so on up to decile group 10, which contains the richest tenth.

 

Source: Author’s calculations using the IFS tax and benefit microsimulation model, TAXBEN, run on uprated data from the 2009-10 Family Resources Survey.

 

Some have argued that a higher income tax allowance would be a good way of introducing a short-term fiscal stimulus for the economy. In our annual Green Budget, we argued that the case for a fiscal stimulus was not clear cut, but said that if the government did choose to introduce one, it should be timely, targeted and temporary. Increasing the personal allowance does not seem to meet any of these criteria. An increase in the allowance would not be especially timely: individuals would not see the effect in their pay packets until the Autumn. It would not be well targeted: the Office for Budget Responsibility suggests that increased investment spending or spending on benefits (or indeed cuts to the main rate of VAT) would deliver a larger direct boost to the economy in the near-term. And being a long term government ambition it would not, of course, be temporary.

Increasing the income tax allowance takes low income people out of income tax. Therefore, it is the best way of focusing income tax cuts on those with lower incomes. And it will strengthen work incentives, especially for low earners. But it is important not to claim too much for a policy which, especially in the current fiscal climate, is expensive. By definition it will not help those on the lowest incomes, who do not pay income tax anyway. And in the current context it is clearly not the best way of delivering a short term fiscal stimulus – and it should not be pursued for that reason. Any stimulus needs to be timely, targeted and temporary.

http://www.ifs.org.uk/publications/6045

 

Manchester is ranked in the top ten authorities worst hit by Government cuts, according to new figures.

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Labour have accused the Government of targeting the country’s most deprived areas to reduce spending, while protecting affluent regions.

Analysis released by the party suggests that the north of England and inner-city parts of London are taking the brunt of the cuts to welfare and local councils.

The figures amount to an average of £508 cuts for every person in the North West, £566 in the North East, and £511 in the capital.

This is compared to just £292 in the South East outside London and £324 in the east of England.

Manchester is the seventh hardest hit authority in terms of cuts, despite being ranked fourth highest in the Government’s own deprivation figures, according to Labour’s figures.

The worst-hit area, Knowsley in Merseyside, sees a total loss of £850 per head – £515 per head in welfare cuts and £336 in local government cuts.

By contrast, the least-hit area, Mole Valley – which covers the towns of Dorking and Leatherhead and surrounding villages in Surrey – loses £182 per head, made up of £164 in welfare reductions and £18 in local government cuts.

The list of ten local authority areas hardest hit by the cuts includes seven out of the eight most disadvantaged parts of the country, according to the Government’s own deprivation index.

Knowsley, which ranks fifth in the index, is followed by Westminster (87th in the index, losing £824 per head), then Hackney in east London (second in the deprivation index, £821), Liverpool (first, £817), Blackpool (sixth, £792), Hartlepool (24th, £724), Manchester (fourth, £715), Newham in east London (third, £710) and Middlesbrough (eighth, £696).

Mole Valley is 310th out of 326 in the deprivation index, and the other areas on which the cuts are having least impact are equally well-off. Second least-affected is Waverley in Surrey (321st on the index, losing £187 a head), Wokingham in Berkshire (325th, £189), Hart in Hampshire (326th, £194) and Elmbridge in Surrey (320th, £196).

Shadow work and pensions secretary Liam Byrne said: “The Tories are zeroing in on areas in need and hitting them hard – twice.

“Communities facing the biggest hit to local government are also losing most from cuts to their tax credits and benefits, yet instead of helping working families the Tories are giving millionaires a tax cut. That tells you everything you need to know about this Government’s priorities.”

According to Labour’s figures, based on independent research conducted by Sheffield Hallam University and Newcastle City Council, the overall loss per head from welfare and local government cuts is £566 in the North-East, £511 in London, £508 in the North-West, £421 in Yorkshire and the Humber, £388 in the West Midlands, £364 in the East Midlands, £334 in the South-West, £324 in the East of England and £292 in the South-East.

See Map – http://www.manchestereveningnews.co.uk/news/greater-manchester-news/manchester-one-worst-hit-places-government-2995627

Measuring Leviathan: Big Government and the Myths of Public Spending | Whitehall Watch

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Posted on January 14, 2013 by Colin Talbot

The political debate about public spending in the UK is bedevilled by myths and spin about how much we actually spend. So I thought it was time for a little myth-busting primer, with some pretty diagrams, about how we should be discussing public spending….

There are three main ways of measuring public spending, each of which has advantages and disadvantages.

Nominal (Cash) Spending

The first is in what is technically called the “nominal” amount spent – that is in actual cash that goes out of the Treasury coffers. Because of the effects of inflation, this nearly always rises (see Figure 1). Only twice in the past half century has the cash amount fallen – in 2000-01. It is forecast to fall again, for one year only, in 2012-13.

This is useful to some who want to argue that the State spends too much – for example some right-wing Conservative politicians and think-tanks currently claim that we are not experiencing “cuts” because the actual amount of cash being spent by the government continues to rise. Figure 1 makes it look like the State is an ever-increasing devourer of resources. But if inflation in prices is taken into account, things look a bit different.

Figure 1 Public Spending in ‘nominal (cash) terms 1965-66 to 20214-15 (£ billion)

Fig 1

Source: based on HM Treasury[i]

Real-Terms Spending

Real-terms spending is the amount spent with inflation taken into account.

Figure 2 Public Spending in Real-Terms (2011-12 prices)(£ billion)

Fig 2

Real-terms spending shows a far less dramatic increase than nominal spending, and some periods where spending levelled-off or even decreased. It shows, for example, a significant (mainly forecast) decrease in real-terms under the current Coalition government.

Again though, this way of looking at public spending can make it look like the State is a more-or-less ever expanding beast soaking up more and more of the nation’s wealth. This may, or may not be true – but the only real way of knowing is by seeing how public spending compares to nations wealth.

Spending as a proportion of GDP

Gross Domestic Product (GDP) is the main measure used by governments and others to estimate how wealthy countries are. There are many criticisms of GDP measurement, which we won’t go into here, but it’s the best we have at the moment for tracking growth (or lack of it) in our won economy and comparing our economic performance with other countries.

Public spending as a proportion of GDP has thus become the main, and most useful, way of tracking how much our national wealth we devote to public activities as opposed to private enterprise.

It’s main fault is obvious: because it is a ration of public spending and GDP a sudden change in GDP can easily look like a sudden change in public spending. Thus, for example, it looks like public spending suddenly sky-rocketed in the last three years of the last Labour government (see Figure 3) – whereas in fact (in real-terms – see Figure 2) it only increased slightly. The sudden change from 40.7% of GDP to 47.3% was almost entirely due to the recession the UK experienced as a result of the Global Financial Crisis (GFC).

Figure 3 Public Spending as a percentage of GDP (1965-66 to 2014-15)

Fig 3

Public spending as a proportion of GDP has averaged just under 43% of GDP (42.76% to be more precise) for the past 50 years.

It has swung between as high as 50% (under Labour 1975-76) and as low as 35% (also under Labour in 2000-01).

But what a detailed analysis of these figures shows is that some of mythology that passes for political “facts” in Britain is just that – myth.

The first is that Labour is always the “tax and spend” Party whereas the Conservatives are far more thrifty with the public’s money.

The facts are rather more mixed (see Figure 4). It is true that the 74-79 Labour Government spent on average more, as a proportion of GDP, than any other government in the past 50 years – but this is not true for the other periods of Labour government, when Labour spent less, on average, than the Conservative (or Conservative led) governments.

In particular the widespread myth that the last “New” Labour government spent vastly more is just that – a myth. On average, even including the effects of the GFC, the last Labour government spent the least of the Governments since 1965. The myth has grown up because both Labour and their opponents wanted to promote the idea Labour spent lots. And because, especially between 2000 and 2005, Labour did rapidly increase spending – especially on health and education – but only after a period of unprecedented low spending between 1997 and 2000.

Figure 4 Public spending as percentage of GDP under different Governments (1965-2015)

Fig 1

This analysis only covers one aspect of public finances – spending – which is itself only one measure of how big the State is. But I hope it will help people to explain, and explore, some of the real issues about public spending rather than trading in myths and spin.

[i] All the figures used in this analysis are based on Public Expenditure Statistical Analysis (PESA), published annually by HM Treasury. The figures for 1971-72 to 2014-15 are taken from PESA 2012. For 1965-66 to 1970-71 are taken from PESA 2003. Some of the calculations are my own, based on the HMT figures.

via Measuring Leviathan: Big Government and the Myths of Public Spending | Whitehall Watch.

Living standards report shows bleak future of a divided Britain

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Independent study suggests rich will get richer and the poor poorer as chancellor plans further £10bn of welfare cuts
The Observer, Saturday 22 September 2012 21.29 BST

Chancellor George Osborne has been accused of ‘waging war’ on Britain’s poor.
Living standards for low- and middle-income households will fall until 2020, even if the country enters a golden period of steady economic growth, according to an incendiary analysis of deepening income inequality in Britain.

The independent study, carried out for the Resolution Foundation by the Institute for Fiscal Studies and the Institute for Employment Research, paints a stark picture of a nation increasingly polarised between a poorer half whose incomes are set to fall and a top half whose living standards will continue to rise.

As the political conference season opens in Brighton this weekend with Nick Clegg’s Liberal Democrats promoting themselves as the party of “fairness” in austere times, the research will pose far-reaching questions for politicians across the spectrum. The chancellor, George Osborne, has been accused of “waging war” on Britain’s poor as he looks to cut a further £10bn from the welfare budget by 2016. But as pressure grows on the government to ease austerity measures and launch a push for growth, the new study makes clear that even a resurgent economy will not solve the problem of Britain’s increasingly divided society.

Entitled Who Gains from Growth?, the study makes clear that future prosperity for the bottom half of earners depends on a policy revolution on several fronts: increasing the number of women in work, boosting training and skills, and raising wages for the lowest paid. Without this, the report finds, a typical low-income family will see its net income fall in real terms by 15% by 2020 – down from £10,600 (at 2009 prices) to just £9,000 at the end of the decade (again at 2009 prices).

A typical household close to middle income could expect to see an income of £22,100 in 2020 – a 3% fall from £22,900 in 2009. Overall, by 2020 families who depend on benefits could expect to see an annual decline in income of 1.7%. Meanwhile, the top 50% of households can expect their living standards to grow by 0.2% a year to 2020; and faster for the most affluent. A typical middle income for a working-age couple is roughly £30,000 before tax, rising to £42,000 for a couple with two children.

The findings are all the more alarming as they are premised on generous growth projections for the period between now and 2015, averaging 1.5% a year, and average growth of 2.5% from 2015 to 2020 – levels most economists would currently regard as relatively optimistic.

Professor Mike Brewer, research fellow at the IFS, said all the signs were that with current government policies the trend would be strongly against income growth for the bottom half of households.

“This analysis confirms the strong currents that will be pushing against income growth in the next 10 years, even once a recovery in GDP takes hold,” he said. “Britain looks likely to see continuing polarisation in our labour market as more high-and low-paid jobs are created, skewing the distribution of income growth towards higher income households.

“Meanwhile, support through the tax and benefit system is set to fall over the long-term, meaning that lower income households will tend to fall behind.”

The study identifies several reasons for the deepening divide in living standards. While new jobs are being created, it finds that many are at the top and the bottom of the income scale, with few in the middle. By 2020, it says, Britain can expect 2m more jobs in high-paid professional and managerial occupations and also growth in low-skilled service roles, with more than 700,000 new positions in retail, caring and leisure. But more traditional jobs in the middle – from skilled administrative roles to skilled manufacturing – are drying up.

Gavin Kelly, chief executive of the Resolution Foundation, said: “This is a powerful wake-up call – it gives us the most detailed account to date of the bleak outlook for living standards over the next decade if we fail to tackle some of the underlying weaknesses in our economy. It suggests that millions of families will struggle, to an extent we have not seen in other periods of growth, to progress and raise their incomes. It’s particularly sobering that this outlook is based on optimistic assumptions about growth in the economy with a steadily rising number of people in employment.

“Just as importantly, the study suggests some of the positive choices that could be made that, if taken together, could make a major difference to the living standards of millions of low- and middle-income households over the next decade. It provides us with both a stark warning and the outline of an alternative path.”

In exploring possibles routes out of the crisis, the report examines what the effect would be if wages for low earners were to grow at the same rate as they did in the decade around the introduction of the national minimum wage in 1999. It also projects a future in which Britain matches the proportion of women in work achieved by the best-performing OECD countries, such as the Scandinavians, which is likely to require a big expansion of childcare provision. And on training it looks at the effects of improving intermediate skills, meaning developing vocational training.

For a typical middle income family, the effect of making all three changes would mean an extra £1,600 a year in 2020 compared to Britain’s current path.