In advance of next Wednesday’s Budget, all of the discussion is over whether the top rate of income tax will be reduced to 40p for those earning over £150,000. Up to 160 Conservative MPs are reported to be urging George Osborne to make this move.
One of the arguments many cite for doing so is that the highest earners pay the most tax. The top 1 per cent (who pay the 45p rate) account for 27 per cent of income tax revenue. But this superficially persuasive stat obscures the reality that it’s the poorest who pay the most. With apt timing, the ONS has published its annual study of taxes and household income, which shows that the poorest fifth paid 37.8 per cent of their income in tax in 2013/14, compared with 34.8 per cent for the richest fifth. Regressive taxes such as VAT and council tax easily override the effect of the progressive income tax system. Further analysis by the Equality Trust found that the poorest 10 per cent of households paid 45 per cent of their income in tax, compared to 34.6 per cent for the richest 10 per cent. The UK’s highly redistributive welfare system ensures that the poorest are compensated: 51.5 per cent of households received more in benefits (including in-kind benefits such as education) than they paid in taxes (though is down from 53.5 per cent in 2010/11). But the UK’s regressive tax system remains a rarely-discussed failing.
The Tories’ pledge to increase the personal allowance to £12,500 by the end of this parliament is spun as a measure to help “the poorest” but the biggest winners would be the affluent. As the IFS has found, 69 per cent (£8.4bn) of the £12.2bn per year giveaway would go to working families in the top half of the income distribution, with just 15 per cent going to those in the bottom half. The 4.6 million workers who earn too little to pay income tax would gain nothing. Indeed, the Tories’ accompanying plan to freeze working and non-working benefits means they will lose out. By promising to also increase the 40p rate threshold to £50,000 by 2020, the Conservatives would tilt the tax system in an even more regressive direction. Despite being sold as a tax cut for the “middle class”, just 14 per cent of earners would benefit.
Rather than reducing income tax (the most progressive tax), it would be fairer to cut VAT (raised to a record 20 per cent in 2010) and National Insurance, currently levied on incomes above £7,956. Increasing the threshold for the latter to £10,000 would reduce taxes for 1.2 million workers who earn too little to benefit from an increase in the personal allowance. Alternatively, as the IFS has noted, 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 £10bn per year less”. Yet far from proposing to do so, the government has frozen the Universal Credit work allowance until 2017/18.
The Tories will not explicitly defend a system under which the poorest pay most; their stance relies on public misunderstanding. A recent poll by Ipsos MORI for the Equality Trust found that 68 per cent of the public think the top 10 per cent of households pay more of their income in tax than the bottom 10 per cent. Reforming the UK’s regressive tax system would be both good politics (as the Conservatives seek to claim the “one nation” mantle) and good economics (the poorest are forced to spend, rather than save, and stimulate growth as a result). It is this, not cutting the top rate, that Osborne should make his priority.
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