The higher rate of income tax and fiscal drag
For example, there is no doubt that the government has been targeting spending cuts on a very small proportion of its spending which must be making reform of working age welfare very difficult (that being one of the areas where cuts have been targeted). As the IEA pointed out in 2011, the pensioner part of the welfare budget has not only been protected but, through promises such as the ‘triple lock’, expanded. Others are now echoing the work that the IEA published at that time, but public choice pressures make it very difficult for the government to act. Not only are pensioners numerous, they are especially vocal. After the paper we published in 2011, not only did the IEA receive a large amount of abuse (the letters and phone calls I received far outnumbered letters and phone calls I have received on all other research put together over the last 14 years), but one member of staff even received a death threat.
However, the other plank of the complaint from the former Secretary of State – that the rich benefitted to an unreasonable degree from the 2016 budget – is much more difficult to defend. It is true that there were reductions in capital gains tax. However, there is evidence to suggest that capital gains tax is beyond its revenue maximising point and it can be argued that it involves unjustified double taxation of returns to capital. Nothing was done about the 62 per cent tax rate that exists on a band of income over £100,000 and the ‘temporary’ 45 per cent tax band remains.
Much of the focus of discussion over the weekend was on the rise in the level of income at which individuals will start to pay higher rate tax. This is a measure that helps the quite-well-off much more than the super-rich. But, more to the point, the measure was not as radical as it seemed on announcement (there’s a surprise!) as much of that rise in the point at which individuals pay higher rate tax comes about as a result of the rise in the personal allowance. Moreover, the measure comes after prolonged and extremely large falls in the higher rate tax entry point relative to earnings (which is the correct metric against which to judge the size of different tax bands):
· Between 1980 and 1997, the ‘tax-cutting’ Conservative governments allowed the point at which people started to pay higher rate tax to fall by 31 per cent relative to wages.
· Under ‘prudence with a purpose’ the not-quite-so-scary ‘new’ Labour allowed the point at which people pay higher rate tax to fall by a further 11 per cent relative to earnings.
· Under George Osborne the entry point for higher rate tax has fallen by a further 12 per cent relative to earnings.
These numbers are not additive, by the way, but the total fall in the level of earnings before which people pay higher rate tax was an incredible 47 per cent between 1980 and 2016. It should also be noted that there was a big rise in the entry point for higher rates of tax in 1979 so, if these figures are calculated from 1979, the fall is only 37 per cent.
If we allow for the fact that parental contributions to their children’s higher education were tax deductible, and for the existence of a married couples allowance, and mortgage interest allowance, as well as for life assurance premium relief, all at the highest marginal rate of tax, entry into the higher tax brackets belonged to an even more exclusive club back in 1980.
All-in-all, to return the level of earnings at which people pay higher rate tax to its level in 1980 would require an increase to about £64,000, not just to the £45,000 proposed by George Osborne. In other words, this budget went a tiny way towards reducing the fall in the point at which people pay higher-rate tax.
In a sense, George Osborne has been the victim of his own rhetoric. Perhaps if he had said: “My government has brought a huge number of people into the higher rate tax band. This is regrettable, but I am no worse than my predecessors. However, today, I shall go some way towards rectifying 35 years of bad tax policy”, the budget might have been received differently and the Secretary of State for Work and Pensions might have been a little less hostile. But, the main point is that we should surely stop focusing on the implications for very specific (and not very important) budget measures and think more about the tax system as a whole: Is it coherent? Does it do the job it is supposed to do? And how has it evolved over time?
Prof Philip Booth is the IEA’s Academic and Research Director, and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham.