The post-budget debate over granny tax allowances, family tax credits and pasties has finally died down. Nevertheless, a new JRF study published this week shows that the vital issue lying beneath the headlines – living standards for families – is as important as ever. The Joseph Rowntree Foundation report shows that family living costs have risen twice as quickly as inflation since the financial crisis struck in 2007.
Ahead of the budget last March, CentreForum and Landman Economics jointly published a paper ‘Taxing decisions: the debate between tax credits and personal tax allowances’. It sought to show how the government can best support families in the ‘squeezed middle’ who are generally in work but have below median incomes.
Together we illustrated how the government could raise significant sums to help working families by changing higher rate tax relief, capital gains tax and pension lump sum tax relief. The report then offered different ways in which this money could be spent.
CentreForum argued that a concerted increase in the personal allowances for both income tax and national insurance would be the best policy, whereas Landman Economics called for significant increase in the basic element of the working tax credit and the per child element of the child tax credit.
In the event, George Osborne increased the tax allowance by £630 (to £8,105). Most tax credits were frozen which, in real terms, represented a reduction. However, the per child element of Child Tax Credit was increased by £135 to £2,690. With the coalition committed to increasing tax allowances further to £10,000 by 2015 amid continued austerity, the debate over tax allowances and tax credits will only grow in importance.
Landman Economics showed in our report that substantial increases in tax credits could offer a greater reduction in child poverty and less ‘leakage’ of resources to higher earning families than tax allowances. This is illustrated by the way that the Budget’s increase in allowances have benefited all individuals earning between £7,575 and £115,000, whereas tax credits taper out as incomes rise so only help those who need them most. Landman’s immediate proposals for tax credits would increase the average weekly income of a squeezed middle family by £23, more than the tax allowance proposals which would afford low to middle income families an additional £12 per week and a similar amount for high-earning ones.
At CentreForum, by contrast, we argued that use of tax allowances is preferable because they are far simpler and awarded automatically. Unlike tax credits, which can lead to low-paid second earners being taxed at 73% as credits are withdrawn, tax allowances reward work by offering greater returns. They allow individuals to keep more of their own earned income. Although a static analysis shows that the squeezed middle receive more benefit from tax credit increases, in the longer term family incomes can rise by more if both parents enter work. By focusing on individual rather than household incomes, greater tax allowances offer incentives for second earners in families to work.
Both authors agreed a longer term vision to fundamentally restructure the tax and benefit system. This includes a personal allowance of £20,000 which would take half of the population out of paying income tax altogether, but would leave those earning above £36,000 contributing more because of changes in tax rates. This, along with other measures, would help to deliver a much-needed shift in the burden of tax from earned income to wealth while supporting working households.