Vince Cable bought my vote for £10,000

By DeusExMacintosh

Well… maybe. I’m not cheap but I CAN be bought (as the saying goes) and as one of those from the lower end of the British income spectrum, the Liberal Democrat offer to raise the tax-free threshold to £10,000 looks pretty tempting from where I’m typing.

The BBC economics editor Stephanie Flanders (oakily dokily) was surprisingly sniffy about the limited benefits she saw for low earners given the party’s overall tax package…

The first is that raising £17bn in extra taxes won’t go unnoticed. And they won’t be felt only by the very rich.

For example, they want to raise an extra £1.9bn from capital gains tax, by cutting the annual allowance for capital gains from £10,000 to £1,000. That means anyone who has a capital gain in a single year of more than £1,000 will have to pay tax on it at their marginal rate…

However, you won’t have to be a millionaire to pay more: Anyone who has a second home in the UK or abroad, or a buy-to-let property, or stocks and bonds whose value goes up more than £1,000 in a year, will have to pay more capital gains tax.

… which succeeded mainly in establishing that she wouldn’t recognize someone on a low income if they bit her (and frankly, I’m tempted to).

Low earners DO NOT HAVE a second home. With the overinflated property market in the UK most members of the middle-class are flat-out affording a first home and any spare cash beyond basic survival goes towards a mortgage and if they’re really lucky a workplace/public service pension. The latest national statistics show that the rate of individual UK share ownership is down to 10.2%, despite being as high as 54% way back in 1964. Apart from the estimated two million members of Thatcher’s Generation who benefited from right-to-buy, working class home ownership tends to be restricted to self-employed tradespeople who ultimately bring in a far higher income than a pair of middle-class teachers for example (and incidentally, benefit from more tax advantages by trading as a limited company). These days if you own a second home, you are rich.

Most genuinely low earners are actually in debt, because it has only been the freely available credit of the last decade that has allowed us to weather the periodic storms involved in living on small – and in the case of benefits, fixed – incomes. Living on £60-£80 a week is almost doable … right up until your cooker breaks down and you have to find £300 for a new one on short notice. Servicing debt is the primary driver of the black economy, not flat screen televisions. The investment of choice for low earners is actually a decent credit rating, hence the disappointingly low takeup of even tax-incentivised financial products like personal pensions and Individual Savings Accounts which were supposedly designed to ‘encourage’ investment and savings by people on low incomes.

NEWSFLASH: low earners don’t HAVE anything spare to save or invest – and that’s in large part due to paying so much tax.

Besides paying the interest on debts (often an eye-watering 25%+ in catalogues and sub-prime “doorstep” debt) even those of us in receipt of benefits ordinarily below the tax threshold face an effective marginal tax rate as high as 300%, losing three pounds of benefit for every pound of work we might produce if we were actually silly enough to try. We’re also paying VAT on purchases like everyone else, but this accounts for a much larger proportion of our overall income.

Stephanie isn’t so sure the poorest will gain at all:

According to the Institute for Fiscal Studies (IFS), the poorest fifth of households will include those with incomes too low to pay income tax. In any given year, one third of adults do not pay income tax and one quarter of adults live in a family where no-one pays income tax.

By definition, those households wouldn’t benefit from the higher personal allowance. The biggest gainers from that change would be households where both adults work, and earn less than £100,000 (as now, the higher personal allowance is going to be tapered away after earnings reach that level).

This is only true for those who continue to do no work whatsoever. A higher tax-free threshold will actually encourage both the unemployed and the underemployed already working for low incomes to do more work because they end up keeping more of what they earn. Human beings are naturally motivated to work harder for their own benefit than the government’s. If Flanders believes the proposed reduction in the Capital Gains allowance would be a significant negative incentive (and I’d agree that £1,000 seems far too low) surely she can recognise that the £10,000 personal allowance presents a pretty juicy positive incentive? Economists are supposed to know about incentives.

Under the current system, part-time work simply does not pay and low-skilled workers in sectors like retailing tend to be employed as casuals on the minimum wage of £5.80 an hour. In fact most workers will be offered less than 20 hours a week, taking a working wage barely to the annual tax-free threshold of £6,475. Go to your local shops and I will wager that there is at least one woman behind the checkout who will be working up to three separate jobs in order to generate a full-time wage.

THIS is why so many people who work are no better off than those on benefits. Those low-earners who are able and/or willing to work are only incentivised to do so if they are also willing to negotiate the absurdly complex and expensive tax-credit system which might refund a little of their income tax depending on personal circumstances. The higher threshold means it will be much easier for low earners to determine their own tax liability even on the most irregular work hours, so no more fears of being suddenly presented with a bill for thousands of pounds in overpaid tax credits (to be recouped from future payments) because your work is seasonal.

With sufficient hours it will become worthwhile for both non-earners and low-earners to abandon the nightmare bureaucracy of the benefit system altogether, saving millions on payments of Housing Benefit and Council Tax benefit for instance. It would become worthwhile for disabled people to attempt part-time work (tax-free DLA goes someway to making up for those like myself whose health restricts them to part-time hours) though it’s not clear whether this would be true for those moving from Incapacity Benefit onto the new Employment and Support Allowance taking its place. Given the savaging of Incapacity Benefit recipients by both Labour and the Conservatives (previously detailed in my earlier post on Welfare, I am not an Underclass) it surprises me that the Liberal Democrats aren’t emphasizing this aspect more.

The extra income will also allow the poorest Britons to break the debt cycle and start accumulating assets rather than liabilities, helping to move the country from the current debt culture back to a savings culture. This change would hopefully then percolate up through society. Expect the banks, catalogues and financial providers who have been profiteering from this sector to be most resistant.

So the primary benefit of a £10,000 personal allowance seems to be that EVERYBODY has more money in their pockets, meaning the government and economy will benefit from consumers having more to spend on themselves and their priorities. It is likely to reduce significantly the benefits bill by making part-time work pay and eliminating the tax-credit bureaucracy entirely, destabilizing the “culture of dependence” the chattering classes are always bitching about and increasing participation in the workforce so employers have a bigger pool of motivated workers to choose from. Plus it is likely to decimate levels of consumer debt.

I’m having a lot of trouble seeing this as a bad thing.

20 Comments

  1. Posted April 21, 2010 at 8:41 am | Permalink

    The bookies now have Cameron as PM and Vince Cable as Chancellor of the Exchequer. This election just gets more and more amusing…

  2. Patrick
    Posted April 21, 2010 at 8:47 am | Permalink

    I love the ‘we should pay more tax’ crowd, of which this is a silly subset.

    In a hating kind of way.

    And iirc the capital gains tax only hits on realisations, not on mere annual increases?

  3. Posted April 21, 2010 at 8:53 am | Permalink

    Patrick, this represents a substantial tax cut (in the UK, at least). Cable would love a high tax free threshold followed by a flat rate, but his party won’t let him get away with it.

  4. Posted April 21, 2010 at 12:42 pm | Permalink

    Great post DEM, in that “I will use small words in the hope they understand” sort of way.

    The most progressive income tax system in the Western world as far as I am aware is the US federal income tax system and a large proportion of the US population pays no federal income tax. These two facts are, indeed, related.

    Now. if policy makers would only integrate the tax thresholds and the welfare payment system …

  5. conrad
    Posted April 21, 2010 at 6:18 pm | Permalink

    “I love the ‘we should pay more tax’ crowd, ”

    Patrick, I’d be willing to pay more tax to bring the threshold higher (say, to 30K), and I’m really not a fan of most of the wasteful programs the government has (like most of the middle-class welfare, such as family benefits that you collect up to 150K). I also don’t really see the point of collecting tax down to really small levels, since the amount they get in tax after all the circles and people employed to get it must be tiny.

  6. conrad
    Posted April 21, 2010 at 7:50 pm | Permalink

    I think a fair bit of the churn is crazy also. Why they can’t just use tax credits in most cases really beats me. I still think, however, that the low tax-free threshold is the bigger evil — if it got raised to a decent level (say 30k), you wouldn’t have to worry as much about churn in those levels (where I presume it costs a big chunk of what you collect) or people getting into weird EMTRs, because the weird EMTRs would be at a level where it wouldn’t make much difference in the choice between working and benefits.

    It would be nice to know actually how much raising EMTRs would cost in lost revenues — that way it could be compared to the cost of other things, some of which I think are very silly (like the government subsidizing my health insurance).

  7. Posted April 21, 2010 at 8:36 pm | Permalink

    I must get back to work so can’t stay, but I will point out that high EMTRs always seem designed to pick on poor people, personally. The other problem is the way high EMTRs operate as a byproduct of progressive income tax; trying to explain to many people on the left that the system they’ve designed to soak the rich (although not as much as it used to, to be fair) finishes up soaking the poorest and most vulnerable is really, really difficult.

    And as DEM shows, it’s worse in the UK.

  8. Posted April 22, 2010 at 4:38 am | Permalink

    I think a fair bit of the churn is crazy also. Why they can’t just use tax credits in most cases really beats me.

    Conrad, tax credits are a symptom of the churn and they’ve proven a nightmare to manage for claimants whose circumstances change in the course of a claim. Raising the personal allowance makes them entirely redundant and eliminates the costs of additional bureaucracy.

  9. conrad
    Posted April 22, 2010 at 5:07 am | Permalink

    “Conrad, tax credits are a symptom of the churn”

    I’m really thinking of things like Family Tax Benefit where you get direct benefits up to to $162K (at a guess, that’s about one hundred thousand pounds), which must account for about 99% of the population here that has kids. Why they can’t just say “you get an extra 10,000 tax break for having kids” and save the Centrelink forms at the end of the year beats me.

  10. conrad
    Posted April 22, 2010 at 8:38 am | Permalink

    I’d be happy to see income splitting for tax purposes. The whole situation is like something only a lunatic could think of now. How one could think that the idea of paying different tax rates when you earn $10,000 and your partner $150,000 compared to if you both earn $80,000 has any sense at all defeats me. I seem to remember from my younger days that the tax rules for working two jobs were equally as zany.

  11. Posted April 22, 2010 at 2:13 pm | Permalink

    There’s a fair bit of discussion of income splitting (and ancillary issues) on this Catallaxy thread, which started with a discussion of paid maternity leave and then went into childcare subsidies, allocative efficiency, ABC, you name it…

  12. Labor Outsider
    Posted April 23, 2010 at 9:00 pm | Permalink

    The big problem with tax splitting is that it can reduce incentives for second earners to work, or increase their hours because the second earner is being taxed at a higher marginal rate under income splitting than individual taxation. Effectively, the marginal tax rate of the primary earner falls (usually the male) and the marginal tax rate of the second earner increases. This doesn’t matter too much if the second earner has no wish to remain inside the workforce, but matters considerably if they are considering moving into employment or increasing hours as the routines of children change.

    So, while it is true that the current tax system “favours” double earning families over one earner families, the shift to an alternative would likely have non-trivial effects on female labour supply.

    I’d also note that while on its face the system appears to favour two earners, when young children and childcare are involved, the net income of the second earners after childcare expenses can be considerable, which is akin to an increase in their marginal tax rate.

    As always, in affairs of taxation, things are more complicated than they seem…

  13. Labor Outsider
    Posted April 23, 2010 at 9:21 pm | Permalink

    I should also mention that the labour supply of second earners is more elastic than that of primary earners and a commonly accepted principle of optimal income taxation is that marginal tax rates should be lower for those with more elastic labour supply.

  14. Posted April 25, 2010 at 5:03 pm | Permalink

    Conrad;

    Tax reductions are forgotten almost immediately. A regular cheque, however, is a drip-feed reminder of the great and boundless beneficence of your good friend, The Government.

    Accounting wise they are almost indistinguishable, except for the tax cut being cheaper and better for the economy. But politically they are very, very different indeed.

  15. Labor Outsider
    Posted April 26, 2010 at 7:30 pm | Permalink

    Hi LE

    Giving people the option would complicate things significantly as well as raise questions about fairness for those (without children) that would not have the opportunity to “cherry pick” the tax system that benefited them financially at different points in time. An alternative would be to allow tax splitting and then have an offsetting tax rebate available for women re-entering the workforce.

    I don’t think there is anything politically incorrect about what you said. My wife and I have a two year old son. Right now she isn’t working in part because the country we are living in makes that hard, but also because she wants to be able to be there for him in his formative years. She expects that to change as he gets older though.

    I guess the important things from a social perspective are to get the design of the tax-transfer system right so that people (women most often) have genuine choices about how they achieve whatever balance they decide is right within the context of their families. Too often that is not the case in the sense that one choice involves unnecessary financial penalties.

    And your point about your friends shows how important it is for the system to recognise that families are dynamic. There are permanent stay at home mums and permanent two working families. But for many families, women move in and out of the workforce and alter hours over time according to circumstances. The tax-transfer system has to be designed with that in mind.

  16. Posted April 26, 2010 at 7:35 pm | Permalink

    I’m just wondering if offering income splitting only until one’s children were a certain age would be a way around this conundrum that isn’t as expensive as the French system (which offers both income splitting and cheap childcare).

    Maybe the income splitting could cut out at 5? That would let one parent work part-time, but also signals that by the time kids get to school, full-time workforce participation is the way to go (I am very wary of making the perfect the enemy of the good on stuff like this).

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  1. […] This post was mentioned on Twitter by searchtempo. searchtempo said: Vince Cable bought my vote for £10,000: Well… maybe. I’m not cheap but I CAN be bought (as the saying goes) and as… http://bit.ly/aDumUh […]

  2. By skepticlawyer » There is honour among thieves on April 30, 2010 at 2:03 pm

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  3. By skepticlawyer » Paid maternity leave on June 1, 2010 at 8:11 am

    […] I said on this thread here, I’m quite keen on the idea that people with kids should be able to opt to split their income for tax purposes, and that the […]

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