Tuesday, November 25, 2008

Why Was a VAT Cut Better Than Raising Tax Allowances?

When Bob Piper and the Adam Smith Institute agree on something it is time to sit up and take notice. Over the weekend the ASI released a policy paper calling for personal income tax allowances to be raised to £12,000. Due to the budget leaks, it didn't get much traction. So now that all the excitement is dying down, let's look at what Tom Clougherty and his colleagues were proposing. This is an extract from the ASI blog...

* Raising the personal allowance to £12,000 would take 7 million low-paid workers out of the income tax net altogether. People earning the minimum wage or less would pay no income tax at all.
* To the average worker, this would be like getting an extra £1,730 a year in gross pay, leaving them £100 per month better off and reversing the substantial falls in disposable income that have occurred over the last 12 months.
* If the Chancellor wanted to give this measure retrospective effect for the current tax year, it would mean a one-off £1,800 'Christmas rebate' for the typical dual-earner family, plus £200 per month thereafter.
* This tax cut would put almost £19bn per year back in people's pockets, allowing considerable additional spending and investment in the productive, private sector economy. This is the key to overcoming recession and restoring economic growth.
* As well as stimulating the economy by giving people more disposable income to spend and invest, raising the personal allowance to £12,000 would strengthen incentives to work, help to eliminate the 'benefits trap' and make low-paid jobs more economic – greatly increasing opportunities for the unemployed.
* If the higher rate threshold were kept at its current level, rather than raised in line with the personal allowance, this policy would cost the Exchequer just £18.9bn a year in lost revenue (it would cost £25bn if we raised the higher rate threshhold too). Of course, this calculation is based on a static analysis, and because of the effects outlined above, the actual loss could turn out to be smaller.
* Either way, I argue strongly against the government financing this tax cut with increased borrowing, suggesting they balance it by reducing public sector waste and cutting spending on non-essential programmes instead. The taxpayer already spends more than £30bn a year on servicing government debt, and we shouldn't add to that burden when there is so much fat to be trimmed elsewhere.
Interesting stuff. I agree with Tom that a measure such as this would have a far bigger effect in providing a real fiscal stimulus, rather than a small cut in VAT. But as Tom points out today...

For the £12 billion cost of Darling's 2.5 percent VAT cut, he could have raised the personal allowance to £10,000 instead.That would have taken 4.3 million people out of income tax, and saved a typical dual-earner family £133 per month.

It would, though, still have to be financed in the short term by massive borrowing unless there was a real willingness to cut government spending. And the ASI naturally have many ideas as to how that can be done.


graybo said...

Interesting. But I don't think an £1800 lump sum would have been workable. Many small companies don't have that sort of cash laying about (if you have, say, 20 employees, you'd have to conjure up £36K) as it would be employers who would fund it before setting it against the tax due in the next PAYE payment to HMRC. So I'm not sure that this would be workable - but the rest of it makes sense.

Old BE said...

Graham, presumably HMRC would mail a cheque rather than it being paid through PAYE?

graybo said...

Blue Eyes - if my memory serves well, you can request an advance from HMRC if you need funds to pay a tax rebate. But there would be an administrative burden on both business and HMRC and many businesses who had cash would not be eligible (and would therefore have to divert cash resources from other things). Surely better to phase it over two or three months.

strapworld said...

sop common purpose referred us to the usa. I visited www.opencurrency.com amd I copy below their article on Whats wrong with the dollar. substitute pound for dollar:-

What's Wrong with the Dollar?

Let's face it: since the beginning of time, every paper FIAT currency has failed. The Federal Reserve Note, once regarded as the world's "reserve" currency, is dying. While on it's death bed, it robs We The People of our wealth through inflation. No one is going to fix this for you: it's time for you to do something about it.

America's Founding Fathers regarded economic independence as the root cause of the revolutionary war. America was a chance to start new, and our country was founded on the constitutional law that no state shall "...make any Thing but gold and silver coin a Tender in Payment of Debts...". After that clever notion was dismissed, and when Congress out-sourced the production and management of Legal Tender to the Federal Reserve Bank in 1913, our fate was sealed. Paper money was now to be the accepted form of monetary exchange, subject to whatever inflation or deflation the Federal Reserve deemed necessary to ensure the country's banking and economic success. Now, almost 100 years later, a dollar buys less than $0.03 of what it did when the Federal Reserve came into power. Further, it's becoming well known that the Federal Reserve is a Private bank, owned by a collection of the world's wealthy elite.

It's now painfully obvious as to why our country is losing our global "super-power" status: we have become a nation of credit. Our financial system is based entirely on debt. Our government is growing at an exponential rate, and the national debt grows right along with it. We spend more than we make; we consume far more than we produce. And the Federal Reserve prints money any time it wants it. There is no accountability; there is no transparency. And for a long time, there was nothing you could do about it.

Wrinkled Weasel said...

"People who have done quite well over the past few years will pay a bit more," Mr Darling told BBC Radio Four's Today Programme. "The burden is falling on people on higher incomes" (Telegraph)

"Pay a bit more"????

I am one of the lucky ones. My Council Tax is frozen, but for some, the rise in council tax payments has risen 90% since Tony Bliar got into power, so they

"pay a bit more"

Everything else I need has risen in price. If you travel in Europe, since last November, every £100 spent is worth about £30 less, so we have to

"pay a bit more"

Utility bills have risen. Road Fuel is taxed at an incredible 81.5% of its actual cost - the highest in Europe, so in Britain we

"pay a bit more"

Because of PFI some must pay to park at their place of work, not a lot, just a bit, so that we,

"pay a bit more"

When Bliar abolished the assisted places scheme for independent education, parents had to

"pay a bit more"

One thing is very clear from The latest round of grand theft, the true figures will be hidden and substantial and we will all

pay more, and more, and more and more and again.

To see this country imploding like this is a tragedy. To think that enough people are stupid enough to have voted them in for a third term confirms my beleif that countries always get the leaders they deserve.

PixieSimon said...

Have just been crunching some numbers. The tapering off of personal allowances for people earning over £100k plus the increase in NICs means that every pound earned between £100k and about £107k will be taxed at a marginal rate of 61.5%. 61.5% for God's sake!

Once employer NIC is taken into account, the Government would get 74.8p for every 38.5p the worker gets. 66% for the government, 34% for the worker.

Great incentive, eh?

Brian said...

It's simple. Taking 7 million low-paid workers out of the income tax net would mean fewer people dependent on Gordon for tax credits. Nulabour doesn't want the low paid to gain any independence. They might start wanting a say in running the country

AloneMan said...

I agree with the sentiment - income tax would be a better target than VAT. BUT there's no point in doing either if they have to be funded by yet more borrowing.

Theo Blackwell's blog said...

"People earning the minimum wage or less would pay no income tax at all."


The Editor said...

I think you'll find that this will have little effect other than to...


Anonymous said...

Dizzy points out that the bad news leaked put yesterday under cover of really really bad news came from Jack Straw this time.

To do with data protection nor lack of it.

"confer a power upon the Secretary of State to permit or require the sharing of personal information between particular specified persons, where a robust case for doing so exists."

JoeF said...

All this is playing while the UK (budget) burns.

The real deficit next year (on realistic assumptions) will be at least £150 bn (not 118). This excludes unfunded pensions, PFI, bank bailouts, etc.

The question is not what tax cuts should have been made, but that actually £20bn is quite small beer and will have not much effect at all, while the £150bn of tax rises/ spending cuts needed later will be a nightmare.

JoeF said...

An interesting detail is that working and middle class people face enourmous marginal tax rates.

Excluding council tax benefits, free school meals etc (some of these go out 100% at certain income levels, so marginal tax rate can easily be over 100% if they apply- I have previously had staff ask not to have a pay rise, as they would actually lose money net), just looking at income tax and NI some approximate figures are-

Penson earns £5,000, no tax or NI, so cost to firm 5k, tax credits etc about 10k, so total income 15k

Person earns £40k, NI to employer makes cost 45k, tax and NI approx 10k, so net 30k.

So if a company spends 40k more on a staff member, the employee only actually gets 15k more- a tax rate around 2/3!

This is absolutely ridiculous and of course makes the 40/45% tax bands look quite attractive!

Anonymous said...

Most of my income goes on things which are VAT free or at the lower rate already, rent, food, energy/utilities, second hand and ebay stuff etc. So it makes no benefit at all to me. Other than beer, which is dearer....