Living Standards, the Deficit & the Personal Allowance
The political appeal is obvious – it can be seen as addressing the ‘cost of living crisis’, sold on progressive grounds as ‘taking the lowest paid out of tax’ and also is a tax cut for higher earners worth around £500 per year (20% of the £2,500 increase).
However, despite the obvious political appeal, increasing the tax free allowance is a poor way of dealing with the squeeze in living standards.
First, as Gavin Kelly points out in the FT article, the policy would do nothing for the lowest 5 million earners who already pay no income tax.
Second, this is expensive, as the IPPR have noted this sort of increase would cost around £8bn.
Third, it ignores the impact of indirect taxes on personal finances and the distributional effects of taxation. As the ONS have clearly demonstrated low earners pay a greater share of their income on indirect tax rather than direct.
Indeed, even the third quintile (the ‘squeezed middle’) have a greater indirect than direct tax burden (17.3% of income versus 15.9%).
The real winners from this policy would be comparatively better off households with two earners both making more than the personal allowance.
Regardless though of the merits of this approach, I think the fact that it is being considered at all tells us to two things about the about the mindset in the Treasury at the moment.
First, the Treasury clearly thinks the public finances are improving. The Chancellor has pledged to be running a surplus by the end of the next Parliament and yet is considering a £8bn tax pledge for 2015. Reading between the lines, I suspect that the Treasury is expecting substantial positive revisions to the OBR’s public finance forecasts either at the Autumn Statement or in Budget 2014. I suspect we’ll see gradual upward revisions rather than a one off sudden shift – it wouldn’t do the OBR’s credibility much good to suddenly announce ‘hang on, things are no where near as bad as we said a few months ago’.
The Treasury is also signalling here that the priority, if the public finances, improve is tax cuts.
Second, this approach reveals a grand lack of ambition. The Conservative answer to an unprecedented living standards squeeze appears to be tax cuts. This also appears to be the Conservative answer to most economic problems (‘economy doing badly – cut taxes to boost growth, economy doing better – excellent we have room for tax cuts, economy bouncing along at a moderate pace – maybe we should cut taxes’).
There is much that could be done to address the living standards squeeze – looking at how the National Minimum Wage is set, at how our labour works, at systems of corporate governance, at the question of market failure, at the very structure of our economy. Instead of this though the government is going down the old fashioned road of simply cutting taxes.
At it’s heart, the living standards crisis is a pay crisis. A real answer measn addressing the cause of the problem not fiscal tinkering around the edges.