Making work pay – how taxes should work better for the ‘squeezed middle’

by Stephen Tall on July 31, 2012

The Resolution Foundation helped give birth to the phrase ‘squeezed middle’: that group of low-income individuals and families just above the threshold to qualify for most welfare help, but only just able to make ends meet, and always in danger of slipping back into poverty.

Today they’ve published a report written by Paul Johnson, Director of the Institute for Fiscal Studies, identifying key reforms that could allow the tax and welfare system to redistribute more efficiently. Here’s the summary-of-the-summary:

Simply making the current system more generous to those on low incomes will not be sustainable in the long run. Reforms to the structure of welfare, VAT and council tax are required.

The tax-benefit system must do more to ensure work pays for groups who we know respond to incentives and which will be important to rising living standards:

· For parents, cash benefits could be made more generous for younger children and less generous for school-age children when parents are more likely to want to work
· For second earners, the new Universal Credit system could introduce a separate disregard for second earners, allowing them to keep more of the money they earn
· For older workers, National Insurance Contributions (NICs) could be reduced by either bringing forward the age at which people stop paying NICs to 55 or by or increasing the NICs threshold at this age, whilst potentially delaying the age at which Pension Credit becomes available.

The report also argues that politicians must finally grasp the nettle of Council Tax reform. Currently people in lower value homes pay a higher rate (as a proportion of their home value) than people in more expensive homes. The report notes that we don’t charge VAT at a lower rate on a Ferrari than on a Nissan. So why do we charge council tax at a lower rate on a mansion than on a council flat? A flat rate of Council Tax would be both fairer and more efficient. In the short-term, additional bands at the top could enable a freeze on Council Tax for those lower down.

The report also argues that the current system of extensive zero and reduced rating of VAT – much more extensive than in other countries – is an expensive and inefficient way of effecting redistribution. It can be reformed over time in ways which benefit low and middle income households.

You can read Resolution Foundation’s report in full here. Well worth reading, incidentally, in conjunction with CentreForum’s recent analysis of the debate between tax credits and personal tax allowances as ways to help the ‘squeezed middle’.

* Stephen Tall is Co-Editor of Liberal Democrat Voice, a Research Associate for the liberal think-tank CentreForum, and also writes at his own site, The Collected Stephen Tall.