Thirty years of fiscal drag
The following graph shows the personal tax allowance (the amount of income on which no tax is paid) from 1978 to 2010:
Even the recovery in the personal allowance at the end of the period only took place because of the controversy over a completely different issue (the abolition of the 10 pence rate of tax) and the desire of the Chancellor to throw some scraps to the electorate – though there has now, finally, been a policy change under the coalition since 2010.
There was a big increase in the allowance in Geoffrey Howe’s first budget and, if we take the core period from then until 2008, the personal allowance fell, relative to wages by well over 20%.
If the picture looks grim at the bottom end of the income scale, it looks grimmer still for the middle class. Higher-rate tax – once the domain of the rich – is rapidly spreading to those who are not remotely well off (especially if they are living in the south-east of England). The following graph shows the amount of income on which basic rate tax is paid:
Essentially, after the 1979 emergency budget, the higher rate tax band has dropped relative to wages by nearly 40%. Although the amount of untaxed income that we are allowed to keep is being increased over the period from 2010 to 2013, the amount of income we can earn in addition to that before we pay higher-rate tax is falling by a further 10% in just three years. This will mean that relative to wages the amount of income on which basic rate tax is paid will have halved in just over 30 years. If the next 30 years is like the last 30 years (and there is no sign of a slowdown, never mind a reversing of the trend), individuals on average salaries will be paying higher-rate tax in the whole of the UK (the picture is much worse in the south east).
What is the problem here? Technically, the problem is fiscal drag. Tax allowances are indexed to prices and not to wages. That means that, as real wages rise, the Exchequer increases tax receipts as a proportion of our incomes. Indeed, even the inflation indexing has been weakened recently (and is sometimes suspended). Allowing this to happen is an easy way for the government to increase the tax take without advertising it. It is a ‘public choice’ problem. Tax cuts (and means-tested benefits increases) can be targeted at interest groups and they can be financed by a silent tax increase spread across the whole population.
It has, however, gone too far (indeed, it had gone too far by 1984). Hopefully, a young MP might be able to make his mark like Rooker, Wise and Lawson did in the 1970s and propose the statutory indexing of tax allowances to average wage levels. Then the government would have to explicitly announce and call for a vote when it chose not to implement the indexation.