Lib Dems should look beyond the tax system to help low-to-middle income families
Liberal Democrats should consider alternative ways to support the incomes and work incentives of low-to-middle income families, which are more focused and avoid the need to give significant tax cuts to families in the top half of the income distribution
The Liberal Democrat conference has seen the party reiterate its commitment to using increases in the income tax personal allowance to raise the incomes of low-to-middle income families. Senior party figures have used conference to stress their long-term ambition to work towards an allowance of £12,500, roughly equivalent to the earnings of a full-time worker on the minimum wage.
This would be a significant tax cut that the Institute for Public Policy Research estimates would cost around £24 billion if implemented today. The Liberal Democrats argue that raising the allowance demonstrates ‘fairness’ by removing many low wage workers from income and cutting the tax bills of many more.
The move would also improve work incentives for many low earners and people out of work who may expect to move into low paying jobs. The symbolic figure of £12,500 also suggests there is a moral case against asking minimum wage workers to pay income tax.
The Liberal Democrat policy is based on a well-founded concern to support low-to-middle income families. The problem is that their chosen method is untargeted, and therefore very expensive, with most of the money spent going to better off families. Everyone earning more than £12,500 and less than £100,000 gains the same amount from raising the personal allowance to £12,500 – £1,005 a year compared to the current allowance of £7,475.
People earning between £12,500 and £100,000 are concentrated in the top half of the income distribution, whereas people who do not work or do not earn enough to pay income tax are concentrated in the bottom half. Therefore more of the money spent on increasing the allowance has to be spent on the wealthiest half of families – about two thirds of the total, according to the Resolution Foundation.
This could be reduced by lowering the threshold at which taxpayers start paying the 40 per cent rate, although this would be very unpopular and probably out of the question for the Liberal Democrats’ Coalition partners. But there is no avoiding the fact that taking some low earners out of income tax necessitates spending large sums on tax cuts for higher earners, while doing nothing to help the lowest earners.
The Liberal Democrat proposal is also directly contradicted by the Coalition’s policy of short-term cuts to working tax credits, which are well-targeted at low-to-middle income working families. Cuts of at least £1.6 billion are planned for 2012-13, reducing work incentives and incomes for these families.
The Coalition is committed to spending £1 billion on a further increase in the personal allowance in 2012-13 but this money could be better spent by reversing some of the damaging cuts to working tax credits, particularly cuts to financial support for childcare.
In the longer term, the Liberal Democrats should consider alternative ways to support the incomes and work incentives of low-to-middle income families, which are more focused and avoid the need to give significant tax cuts to families in the top half of the income distribution.
The party is rightly seeking to put support for low-to-middle income families at the heart of Coalition policy but relying primarily on the tax system to achieve this means the money it has carved out for this policy is not being spent as effectively as it could be.
Alternatives could include investment in free, universal childcare and early years education, which enables parents to work and supports children’s development. It could also mean looking again at the Universal Credit to see if additional and more targeted support can be offered to working families on low-to-middle incomes, including those who would not benefit from an increase in the personal allowance.