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Why the Lib Dems' £12,500 tax allowance promise is a smaller pledge than it sounds

Inflation alone will ensure that the allowance rises to over £11.3k and minimum wage workers will still be paying tax.

nflation alone will ensure that the allowance rises to over £11.3k.
Nick Clegg speaks at the Liberal Democrat spring conference in York last weekend. Photograph: Getty Images.

Since the weekend, when the Lib Dem faithful gathered in York for their spring conference, quite a few column inches have been filled with frothy speculation about Nick Clegg’s likely longevity as Liberal Democrat leader. Nothing, however, has been written about the new twist he gave their proposed tax policy (Lib Dem blogger Mark Pack being the honourable exception). Clegg’s remarks may have sounded like a passing aside – but they were fiscally and politically significant.

The context was that Clegg – like Danny Alexander – spent the weekend seeking to highlight the Lib Dems' flagship commitment to remove minimum wage workers from income tax in the next Parliament via a personal tax allowance (PTA) of £12,500. The not-very-hidden-message was that this will be top of their demands in any future coalition talks.

It is an odd policy in many ways. I’ve written before about why it isn’t what it’s billed to be. It’s not a tax cut for the lowest paid (the 5 million lowest earners don’t’ get a penny); nor is it really about lifting people out of income tax (roughly 10 per cent of the cost of the policy goes on this). It isn’t targeted at those on the minimum wage (the clear majority of whom are part-time workers who don’t pay income tax); and it’s certainly not well designed to reach those fabled "hard working families" (just 15 per cent of the gain goes to working families in the bottom half of the income distribution). In a world of Universal Credit (UC), it’s an even more regressive than people realise: millions of low and middle income working families will have most of their gains immediately withdrawn via a lower UC entitlement. And there is no policy justification whatsoever for raising the PTA once again while leaving the national insurance threshold at a far lower level – a point that even senior Lib Dems concede in private. But none of this is new.   

What might have been news, however, was Clegg’s apparent clarification that the aim of Lib Dem policy for the next Parliament is to “stick at £12.5k” (£12.5k being around the earnings of a full-time minimum wage worker in 2015). I’m told this really means setting the goal of a PTA of £12.5k by the end of the Parliament in 2020; in exactly the same way that in 2010 Clegg made an allowance of £10k the lodestar for 2015.

The details really matter here. Reaching an allowance of £12.5k by 2020 is very much less ambitious than moving straight to a PTA of £12.5k in 2015/16, and dramatically less stretching than committing to uprate a £12.5k allowance in line with increases in the minimum wage over the next Parliament (which is the implied logic of the policy). Even without further increases in the PTA in next week’s Budget, or indeed in Budget 2015, we would expect inflation alone to ensure that the allowance rises to over £11.3k by 2020 (the default for the PTA is that it rises in line with CPI). Inflation is the friend of those seeking to boast of a higher income tax allowance.

The extra cost of going from £11.3k to £12.5k by 2020 is about £6bn over the next Parliament (more if UC doesn’t come in). But moving straight to a PTA of £12.5k in 2015/16 would cost over double this amount. And uprating a £12.5k allowance in line with the minimum wage would cost far more still. Indeed, Clegg’s remarks suggests he’s realised that this continued link to the minimum wage, the stated justification for choosing £12.5k in the first place, would not only cost an exorbitant amount, but it would also mean that the Low Pay Commission (who determine the minimum wage) would in effect be in charge of a central element of tax and fiscal policy. And that was never going to happen.

So the defining commitment at the heart of the Lib Dem manifesto is actually likely to be to raise the PTA by a bit over a thousand pounds more than it would have otherwise gone up by over the whole of the next Parliament. Regardless of whether you think this is a smart or silly thing to promise, what is beyond doubt is that it is a smaller pledge than many realise. (And it’s also a different pledge to that being advertised: a £12.5k PTA in 2020 would mean a full-time minimum wage worker will still be paying income tax in every year of the next parliament.) 

Now, £6bn over the Parliament is still an awful lot of money. All the more so when most of the gains go to those households who are better off, and more than ever in a period of sustained austerity when every taxcut will require another tax rise or, more likely, yet deeper spending cuts that will overwhelmingly hit the poor. But the lower than expected cost is highly relevant to potential 2015 coalition talks. It means the Lib Dem tax plans are likely to represent a less insurmountable barrier to a deal with either of the other main parties than some might think. Clegg seems to have watered down his top demand for future coalition talks without anyone noticing.   

Gavin Kelly is chief executive of the Resolution Foundation