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10p or not 10p?

Ed Miliband made waves last week with his plan to bring back the 10p rate of income tax, funded by a mansion tax. Most political commentators liked it: it was a genuine surprise, sowed division in the Coalition, and got well over the bar on policy interest. It also closed down another bit of political space for George Osborne in his forthcoming budget. Even prominent Conservatives like Tim Montgomerie gave it principled support.

Economists didn’t like it, for the well attested reasons that it adds complexity to the tax system, gives more to better off households than to the poorest, and doesn’t sharpen work incentives as much as employment-related tax credits. These are good economic reasons but they prove once again that economists don’t make good politicians (unless you happen to hold an economics PhD and run for the office of President of Ecuador, perhaps). This was a deeply political move from Miliband and he wasn’t looking for IFS endorsement.

But at IPPR, we’ve been critical of the raising of the personal tax allowance for many of the same reasons that economists have criticised Miliband’s announcement. So how do the two policies compare?

This is what the IPPR tax-benefit model shows for how each policy distributes gains across different households, assuming that a mansion tax raises roughly £2 billion to pay for each policy (this is not the same as looking at the distribution across individual taxpayers, of course, which will be more progressive).

The chart below models (a) a 10p rate on the first £800 of taxable earnings, with no offsetting reduction in the higher rate threshold, at a cost of £2.1bn and (b) an increase in the personal tax allowance of £325, with no reduction in higher rate threshold, at a cost of £2 billion. The April 2013 tax thresholds are taken as the baseline in each case:

Here we can see that the 10p rate wins on progressivity but neither policy performs very well, measured across households (note that if we looked only at individual taxpayers and didn’t care about how they formed households, and excluded those not working or earning enough to pay tax, then both measures would be progressive).

The next chart limits the gain to higher rate taxpayers through a reduction in the higher rate threshold of £163 (in the case of the personal tax allowance case) or £200 (in the 10p case). The costs are now and £1.9bn (personal tax allowance) and £2bn (10p rate). The reduction in the higher rate limit is different because the extra tax paid is different under each case.  The overall picture doesn’t change a huge amount, however:

So Labour and the Liberal Democrats now both have tax policies which have roughly similar distributive effects. If the two parties end up in coalition negotiations after the 2015 election, a mansion tax could be ticked off quickly (and conversely David Cameron will now be hard pressed to reject it if he wants a deal). However, the Liberal Democrats will have delivered a £10,000 personal tax allowance by the next election, so what will they have to trade with Labour’s 10p income tax rate? The current answer – not yet explicitly party policy – is a personal tax allowance of £12,500.

Here’s what that looks like, with a reduction of the higher rate threshold by £1,250 to offset it for higher earners:

Unlike the other options, however, this costs a whopping £14 billion: enough to provide universal childcare and care of the elderly. If they want to avoid further deep cuts to welfare, social housing and local government services, where are they going to find £14 billion? A similar, albeit smaller, fiscal challenge is posed to Labour: if you’ve used up £2 billion to pay for a new 10p rate, where are the resources going to come from for your other priorities?

Hence while tax policy got more interesting last week, fiscal policy got even harder.

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2 Responses to 10p or not 10p?

  1. Jill Rutter says:

    hi Nick: my blog of yesterday with an eerily similar title,,, http://www.instituteforgovernment.org.uk/blog/5430/10p-or-not-10p-that-is-not-the-question/

    not sure tax policy got more interesting…. I think last week’s annoucncments showed a determination yet again to play politics with tax policy in a way that does not serve anyone. the debate needs to focus on the sort of issues you raise on income v wealth taxes and the right structure for income tax.
    discussion tomorrow with the IFS here on making tax policy better – its booked out, but woudl be happy to have you there.

  2. James watson says:

    As far as I can observe the IFS have commented on the economic merits of the proposals. They have not commented on the political merits of the propoals. Rather cheap therefore to suggest that this ‘proves one again’ that economists don’t make good politicans.