Lord Mackay of Clashfern is a former Lord Chancellor.
When the idea of increasing the personal allowance was advanced before the 2010 election – it was then standing at £6,745 – I thought it an excellent idea and wondered why the proposal had not been made before. Cursory analysis demonstrated that this policy would take poor people out of tax- a thoroughly good thing.
In time, however, I was challenged to consider the impact of this policy in greater depth, to reach beyond the obvious impact of the policy and to confront some of its deeper implications. In this regard, I was particularly helped by an Institute of Fiscal Studies assessment of the distributional impact of the policy, which demonstrates that most of the benefit of the recent increases of the personal allowance have gone, and are going, to those in the top half of the income distribution.
The principal reason for this is that everyone benefits from such a rise (apart from those on the very lowest and very highest incomes), including single people with no dependents, two-earner families – who of course get two allowances – and one-earner families. In this context, it is the one-earner families, who tend to be less well-off anyway, who fare the worst. The provision also has the effect of pushing back the point at which those earning over £100,000 lose all their personal tax allowance, and is also of no benefit to those poorer families who already do not pay tax.
To really understand the problems associated with the distributional effect, however, one also has to appreciate that this is a very expensive policy which now costs in the region of £11 billion per annum. In other words, at a time of severe fiscal constraint, the personal allowance policy is being used to redistribute nearly £8 billion per annum to those in the top half of the income distribution, but just over £3 billion to those in the lower half of the income distribution. The poor targeting of the help directed to those on lower incomes through this arrangement sadly rather undermines the claim that this is a progressive policy.
These difficulties, however, will be compounded Theresa May continues with the policy of George Osborne and David Cameron to increase the personal allowance from £11,000, where it is today, to £12,500 by 2020.
According to the 2016 Treasury figures, the cost of the next projected increment in the personal allowance from £11,000 to £11,500 will be nearly £2 billion, on which basis we may assume that the total cost of increasing the allowance to £12,500 will approach £6 billion.
In my view, it is difficult to see how a Government which very properly wants to ‘make Britain a country that works for everyone,’ and which has particular regard for ‘ordinary working class families’, can take an additional £6 billion of public funds and then allocate approaching £4 billion of that sum to those in the top half of the income distribution, but only £2 billion to those in the lower half.
The principal reason why we have got into these distributional difficulties is that we are trying to help people on the basis of individualistic personal allowances, which have no regard for whether the person concerned is single with no dependents, or whether they have a family to support. Income alone is no guide to where you stand on the income distribution, because that depends also on the number of mouths you have to feed.
A far more progressive and targeted approach to making Britain ‘a country that works for everyone’ would be to invest in a tax allowance that is cognisant of family responsibility. In this regard it is very interesting to note that the Government’s other main income tax allowance policy, the transferable allowance, which instead of being individualistic is predicated on the existence of a relationship, has a far more progressive distributional impact.
The comparable IFS graphic shows that this policy disproportionately benefits those in the lower half of the income distribution.
The challenge is that while increasing the personal allowance to £11,000 is costing £11 billion per annum, the Government is only investing £210 million in the transferable allowance (‘the marriage allowance’), which is so small that many eligible couples have not bothered to apply for it. This difficulty is compounded by the fact that, last year, the government spent £245 million supporting marriages where at least one person in the couple was born before 6 April 1935 through the ‘married couples’ allowance.’ On this basis, the government is spending more on supporting the marriages of couples in their eighties and nineties, whose children left home a long time ago, than it is spending on supporting all other marriages, including those with care for dependent children.
I suggest that the Prime Minister and Chancellor use tomorrow’s Autumn Statement to say that no more money should be invested in increasing the personal allowance and that instead that money should be devoted to creating a meaningful transferable allowance. This could be limited to families with children in order to further compound its progressive distributional effect. If the Government feels bound to increase the personal allowance to £12,500, then it should at the very least rule that further increases will be confined to taxpayers with dependent children.