The coalition government is short of policies that the free-market movement around the world might point to in generations to come as being of some importance in rolling back the state. Radicalism does not come naturally to a group of people who err towards the ‘high Tory’ tradition and who are constrained by the cautious Lib Dems whose radical instincts are often in the wrong direction.

The problem of ‘bracket creep’ and fiscal drag is one area where action could easily be taken. This issue is widely discussed in the US and one could certainly see these ideas copied in the States. The Rooker Wise amendment to the 1977 Finance Act required statutory indexation of income tax allowances to prevent unintended tax increases caused by wage increases that merely compensated for inflation. At very little fiscal cost in the early years, the government could take this one step further. Statutory indexation should be changed to being linked to average wage increases (technically, probably, to increases in nominal GDP per head – but there may be virtue in simplicity). If real wages rise by (say) two per cent and all tax allowances rise by inflation plus two per cent then the tax take will rise by two per cent in real terms – as it should.

Currently, if wages rise, the tax take increases by more than the increase in wages – even if we have statutory indexation of tax allowances to prices (which has often been suspended). The following graph shows how the 40 per cent tax bracket has fallen relative to wages over the last 30 years, dragging more and more people into higher rate tax. The higher rate tax allowance today is only 70 per cent of its 1980 value in wage-adjusted terms.

The Chancellor, in fact, has moved in the opposite direction. The statutory increase to tax allowances will be in line with the Consumer Price Index, rather than the Retail Price Index which is a broader and more appropriate measure of inflation (and which, on average, rises more rapidly than the Consumer Price Index). Furthermore, in an utterly disingenuous move, he is leaving excise duties indexed to the more rapidly rising Retail Price Index. This move will lead the Exchequer to take in an extra £1bn a year by 2015, rising year, after year, after year.

The statutory indexation of tax allowances to wages should not stop with income tax. National Insurance thresholds, Stamp Duty thresholds and the Inheritance Tax threshold should be similarly indexed. The average semi-detached house price in over half of London’s Boroughs is now attracting the 4% rate of Stamp Duty intended only for mansions. In the time since Stamp Duty was ratcheted up by Gordon Brown, a house that was comfortably in the 1% band is probably now in the 3% band. A few other things could be thrown in with statutory wage indexation too including ISA allowances, the various restrictions on pension contributions and so on:

There are three reasons to take this the move:

  1. It would mean that, if no further budget decisions were taken, the tax system would continue to do the job it was intended to do – raising the same proportion of people’s income. The tax system would have predictability.

  2. If the government wanted to raise more money it would have to explicitly reduce allowances or raise rates. A government that believed in free markets should want to put such inconveniences in the way of its successors.

  3. The raising of sensitive thresholds which cause great trouble to a small number of people but raise little revenue would be much easier in times of austerity. For example, the Chancellor seems not to want to raise Inheritance Tax thresholds for political reasons in times of austerity. This is a tax that especially hits the middle class in the south east who are not able to use legal mechanisms to avoid it. Raising the threshold in line with wage increases this year might cost something like 0.00004% of government revenue.

This budget measure could be enacted by the coalition government in the 2012 budget and would cost little in the early years. It would be George Osborne’s successors who would actually have the embarrassment of having to raise taxes explicitly if they wished to increase public spending.

Philip Booth 154x154
Philip Booth is Academic and Research Director at the Institute of Economic Affairs and Professor of Finance, Public Policy and Ethics at St. Mary's University, Twickenham. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. Previously, Philip Booth worked for the Bank of England as an advisor on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs and on the editorial boards of various other academic journals. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

1 thought on “A government that believed in low taxation would end bracket creep”

  1. Posted 11/07/2011 at 14:54 | Permalink

    The Rooker Wise Lawson amendment requiring RPI indexation for income tax allowances was intended as a step towards honesty in public sector finance. Unfortunately the present government seems to prefer dishonesty (or maybe ‘stealth’ would be a kinder word). As Philip points out, it is inconsistent (he says ‘disingenuous’ ) to use the RPI for excise taxes and the CPI for income tax allowances. I understand that the switch from RPI to CPI for public sector pension index-linking is expected to ‘save’ the government between £6 and £7 billion in the current fiscal year. I wonder if the Government Office for Statistical Honesty might have a comment? GOSH perhaps?

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