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The problem with Clegg's tax cut plan: it won't help the poorest workers

With the personal allowance already at £10,000, the lowest-paid five million workers will not benefit from further increases.

Nick Clegg speaks at the Liberal Democrat conference in Glasgow last year. Photograph: Getty Images.

There's little more than a month to go until the Budget (on 19 March), so it's time for Nick Clegg's annual appeal to George Osborne to increase the personal tax allowance. In a speech tonight at 6:10pm at Mansion House, he will say that he wants the threshold to be lifted from £10,000 (the level for 2014-15) to at least £10,500 by April 2015. Here's the key extract:

We want to keep cutting income tax for ordinary taxpayers. That will be the main item Danny and I push for in the Budget - again.

In the next parliament we would raise the personal allowance so that no one pays any income tax on the first £12,500 they earn. 

It’s our flagship policy because it’s how we make work pay, and it’s our way of making sure the British people know that this recovery is theirs.

In a smart piece of framing, Clegg is calling the policy a "workers' bonus", although workers who have seen their pay fall for years might reasonably grumble that a small tax cut hardly bears comparison with the pay packets enjoyed in the City of London. But while the move is undoubtedly good politics, and the best example of an area where the Lib Dems have genuinely set the agenda (in the first leaders' debate in 2010, David Cameron told Clegg: "I would love to take everyone out of their first £10,000 of income tax, Nick...We cannot afford it"), it is bad policy. 

At a time of falling living standards, raising the personal allowance will do nothing to help the five million lowest-paid workers who earn less than £10,000. It is those in the second-richest decile who gain the most in cash terms from the policy (mainly due to the greater number of dual-earning households), followed by the richest tenth, who gain marginally less due to the gradual removal of the personal allowance after £100,000 (a brilliant piece of stealth redistribution by Alistair Darling). As a percentage of income, it is middle-earners who gain the most, with those at the bottom gaining the least. 

Progressive alternatives to raising the income tax threshold include increasing the National Insurance (NI) threshold, which currently stands at £7,748, cutting VAT, which stands at a record 20 per cent and hits the poorest hardest, or raising in-work benefits such as tax credits. As the IFS noted last week, aligning the NI threshold with the personal allowance would "cut taxes for 1.2 million workers with earnings too low to benefit from an increase in the personal allowance, would benefit only workers, and would simplify the direct tax system." Alternatively, raising the level at which in-work benefits are withdrawn by 20 per cent would be "a bigger giveaway in entitlements to working families in the bottom three income deciles than the gains to that group of raising the personal allowance to £12,500, despite costing £10 billion per year less". 

But all of these measures lack the headline-grabbing potential of another cut in income tax. For similar reasons, rather than calling for an increase in the NI threshold, Labour is promising to reintroduce the 10p tax rate, a measure that would do even less to benefit the poorest but that offers a useful means of distancing the party from one of Gordon Brown's greatest blunders. All of which is a reminder that when it comes to tax, there are few areas where the triumph of politics over policy is greater. 

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