The graph which shows why the Lib Dem policy of raising the personal allowance is the wrong priority

by Stephen Tall on December 2, 2014

Here’s a graph which should make Lib Dems who continue to advocate increasing the personal allowance as an effective way to help low- and middle-income earners sit up and pay attention.

It’s from the Resolution Foundation’s report, Missing the target: tax cuts and low to middle income Britain, published yesterday.

What it shows is which households gain from the party’s policy to increase the threshold at which income tax is payable to £12,500 over the course of the next parliament. As you can see, those households which benefit most are at the wealthier end of the spectrum; the poorest 20% benefit least.

res fdn tax cuts lib dem graph 1

The Lib Dem policy is estimated to cost some £5 billion. Very little of this cash will actually benefit the least well-off. The Resolution Foundation calculates that, for every £1 spent on raising the personal allowance, just 25p will benefit the bottom 50%. The wealthiest 20% will do better: they’ll get the equivalent of 31p of each £1 spent.

As our modelling (Figure 3) shows, the cash gains from the Liberal Democrat proposal are concentrated in the top half of the income distribution (the biggest proportional gains come in the seventh decile). As we will see in relation to all the parties’ plans, those already below the personal allowance (including those taken out of income tax over the course of the current parliament) don’t gain at all.

Similarly, those set to be taken out of income tax over the course of the next parliament by the above inflation increases in the allowance only receive part of the tax cut. Again a common distributional issue faced by all the parties is that, at a household level, two earner families tend to be richer and gain twice over from income tax cuts, while single earners – regardless of family size – gain only once.

So what should we as Lib Dems be making a priority if we want to cut taxes in a way which is progressive?

Well, the answer is very straightforward. As I first wrote here in February 2013: Focus next on National Insurance Contributions (NICs) – NOT the income tax threshold.

An estimated 1.2 million workers will be paying employee NI from April 2015 (expected to start at just over £8,000) but will be earning too little to pay income tax. Before further increases to the personal allowance, we should be ensuring we take that group out of personal tax altogether.

To be fair, the Lib Dem leadership has partially recognised the issue. In the summer, Danny Alexander announced that, once the £12,500 personal allowance threshold was reached, the party would then look to raise the NI threshold too, and align them.

But there’s two problems with this approach.

First, it’s the wrong way around. As the Resolution Foundation neatly puts it, ‘The logic of this tax-cut sequencing can be questioned. It seems to be to reduce taxes for everyone in the country earning between £10,500 and £121,000 before, at some later date, turning to help those earning as little as £8,000.’

Secondly, it’s completely unaffordable. Raising the personal allowance (£5bn) is going to be challenging enough given the financial constraints that any government will face in the next parliament. To pretend we could then afford a further £9bn (the estimated cost of increasing the NI threshold) is either delusional or dishonest. Frankly, neither’s a good look.

PS: I spoke yesterday (alongside The Times’s Tim Montgomerie and The Guardian’s Polly Toynbee) at the Resolution Foundation event, Tax cuts in tough times, which launched their publication. You can read what I had to say over at my blog here.

* Stephen Tall is Co-Editor of Liberal Democrat Voice, and editor of the 2013 publication, The Coalition and Beyond: Liberal Reforms for the Decade Ahead. He is also a Research Associate for the liberal think-tank CentreForum and writes at his own site, The Collected Stephen Tall.