There is no coalition policy of which Nick Clegg is prouder than the increase in the personal tax allowance. Having achieved the original target of £10,000 (from a starting level of £6,475 in 2010/11) a year earlier than expected, Clegg has been pushing George Osborne to go further – and will get his wish in the Budget tomorrow. The Chancellor is likely to announce that the tax threshold will rise to £10,500 next year and perhaps even to £10,750 if he’s feeling generous. Given the Lib Dems’ limited success in government (no AV, no House of Lords reform, no mansion tax), Clegg is understandably keen to claim credit for a policy that voters overwhelmingly support and that David Cameron rejected as unaffordable during the first 2010 leaders’ debate (“I would love to take everyone out of their first £10,000 of income tax, Nick. It’s a beautiful idea, it’s a lovely idea – we cannot afford it”). For Clegg, the increase due to be announced in the Budget is a step towards the Lib Dems’ new target of a £12,500 tax allowance by the end of the next parliament.
But not all in his party share his enthusiasm for continually hiking the tax threshold. By definition, as the policy continues, it becomes increasingly less progressive. The five million workers who earn below £10,000 will gain nothing from another rise, but all of those earning up to £120,000 will be better off (the personal allowance is tapered away at a rate of 50 per cent after £100,000 – a stealth tax introduced by Alistair Darling). It is those in the second-richest decile who receive the most in cash terms from the policy (mainly due to the greater number of dual-earning households), followed by the richest tenth (who receive marginally less due to the tapering away of the allowance). As a percentage of income, it is middle-earners who gain the most, with those at the bottom gaining the least.
For these reasons, an increasing number of Lib Dems are calling for the party to support progressive alternatives to raising the tax threshold. The Centre Forum, the party’s favourite think-tank, has proposed increasing the National Insurance threshold, which currently stands at £7,748, to help low-earners. As the IFS recently noted, 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.”
The reliably contrarian Lord Oakeshott has echoed this demand, stating that “Raising the income tax starting point to £10,000 is a great Liberal Democrat manifesto achievement but we should declare victory and move on, or we’ll become victims of our own success. We’ve lifted 2 million out of income tax but left 1.2 million of them paying National Insurance contributions from around £7,750 a year.” The Guardian reports that his concerns are shared by his political ally Vince Cable, who has also noted “the diminishing returns of the policy for the low paid.”
Other alternatives to raising the tax threshold include cutting VAT (which is paid by all and hits the poorest hardest) and raising in-work benefits such as tax credits. As the IFS noted, increasing the level at which the latter 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. With the Tories considering making their own pledge to raise the personal allowance to £12,500, Clegg is determined not to relinquish ownership of the policy. But as he continues down this path, the divide between him and his party’s redistributionists is one to watch.