13 March 2019

Scrapping the personal allowance would be a disastrous change to Britain’s tax system


Should the Chancellor raise taxes for everyone earning more than £37,500 in order to fund a no-strings-attached giveaway to the unemployed? John McDonnell appears to think so: on Monday, he welcomed a think-tank report proposing precisely that as “just the kind of innovative thinking we need on how to fix the imbalances and problems of our tax system.”

The report in question is from the New Economics Foundation (NEF). It proposes scrapping the personal allowance – according to which the first £12,500 of earnings will be free from income tax in 2019/20 – and replacing it with a £48-per-week “national allowance”.

The logic behind the recommendation is that £48 per week is equivalent to the value of the personal allowance to a basic rate taxpayer. Under the NEF’s plans, though, a tax-free allowance would become a cash benefit, paid directly to everyone – even if they had no other earnings.

It would be affordable, the NEF say, because abolishing the personal allowance would cause the starting point for higher rate of income tax (40p) to fall from £50,000 to £37,500 in 2019/20. Hence higher taxes for anyone earning above that level.

There’s plenty to dislike about the NEF’s proposal. For one thing, it would wreak havoc on work incentives, given that it couples a huge increase in obligation-free cash handouts (the mooted “weekly national allowance”) with sharper effective marginal tax rates for people trying to get off welfare and into work. Unlike today, income tax, as well as the universal credit taper, would apply to the first £1 anyone earned.

What’s more, the NEF’s proposal would hurt many aspirational middle-class families, who would suddenly find themselves paying the higher rate of income tax despite not feeling remotely rich. It’s worth remembering here that had the higher rate threshold kept pace with earnings since 1988 – the last time our tax system was comprehensively reformed – it would stand at more than £90,000 today. That’s almost double the current level.

But as much as the substance, it’s the way the NEF frame their argument that sets my alarm bells ringing. Here’s how the authors begin their paper:

The recent increases in the personal allowance of income tax represent one of the most expensive and regressive public spending projects of the 21st century so far. Her Majesty’s Revenue and Customs estimate the scheme to be worth an eye watering £107 billion in foregone tax receipts for the 2018/19 tax year alone.

Let’s start with that “eye watering” £107 billion figure. For one thing, isn’t it a bit weird to describe the personal allowance – effectively a zero percent income tax band – as public spending? Do we also “spend” £86 billion on the basic rate of income tax by not setting it at 40p? Indeed – to follow this to its logical conclusion – is letting workers keep any of their earnings actually a kind of public spending? Hmm.

More to the point, £107 billion – a figure plucked from the government’s “Estimated Cost of Principal Tax Reliefs” – isn’t really the cost of rises in the personal allowance since 2000. In fact, the extent to which the personal allowance has risen faster than the rate of inflation since the turn of the century actually costs the government a bit less than £27 billion of annual revenue today – still a lot of money, to be sure, but rather less than the NEF suggests.

Then there’s the question of whether recent increases in the personal allowance are really as “deeply regressive” as the NEF argue. The authors offer three reasons why this should be the case: first, households with little or no taxable income miss out on the benefits; second, dual-income families – which tend to be higher up the income distribution – can get twice the gains; and third, the personal allowance is worth twice as much to a higher rate taxpayer as a basic rate one.

Those first two reasons are hard to argue with, but that’s only because they apply to pretty much any tax cut you can dream up. If you don’t pay any tax, a tax cut isn’t going to benefit you. If two people get a £100 tax cut, that’s better than one person getting a £100 tax cut. Both statements are true; neither tells you much about whether a policy is good or bad. And accepting them would mean never cutting any tax ever again.

The NEF’s third reason – that the personal allowance is worth more to higher earners – is at least correct in theory. But the qualification is all-important. A higher personal allowance will only give a particular benefit to higher rate taxpayers if it also raises the threshold at which earnings become liable to the higher rate. And that simply hasn’t been the case since 2010.

In fact, right now, the higher rate threshold is nearly £9,000 lower than it would have been if it had simply tracked CPI inflation since 2010. That’s occurred just as the personal allowance has risen significantly. So far from higher rate taxpayers seeing an outsize benefit from increases in the personal allowance they have, if anything, been somewhat hard done by. The £50,000 threshold that will take effect in April is an effort to redress the balance, but only up to a point.

Perhaps it isn’t surprising that the Centre for Policy Studies’ head of tax (that’s me) would come out in defence of raising the personal allowance. After all, it’s a policy we’ve been advocating since at least 2001, when our chairman, Lord Saatchi, wrote “Poor People! Stop Paying Tax!”. In our view, a higher personal allowance simplifies the tax system, improves work incentives, and reduces dependence on the state. More to the point, it lets people keep more of their own money – which is almost always a good thing.

But you don’t have to agree with us – or with the 76 percent of the public that backed our call to significantly raise the national insurance threshold as well – to see that the NEF’s case for abolishing the personal allowance rests on shaky foundations. Or that their plan to replace it with a new universal benefit causes more problems than it solves.

Ultimately, whatever John McDonnell might think, there’s nothing here that will solve the real problems that bedevil our personal tax and welfare systems.

Tom Clougherty is Head of Tax at the Centre for Policy Studies.