Don Draper and Leonard Beighton have a combined 60 years of experience advising Governments on tax policy. Together with John Avery-Jones, a retired tax judge, they are co-founders of Tax and the Family.
In our earlier article we explained that a family in poverty can be paying thousands of pounds in income tax. This really does happen. The income tax system needs to be made fairer for families, but nobody is yet talking about this. Corbyn’s Labour is not talking about it and neither are the Liberal Democrats. Surely there is a major opportunity for the Conservatives here if the Treasury can be persuaded to understand the issue.
Together we have spent over 60 years advising both Conservative and Labour Governments on tax policy, and have watched with increasing concern the way in which the income tax system has developed since the introduction of independent taxation in 1990 – before many of today’s parents were born. Those who planned independent taxation had wanted to make the tax system better for families, not worse. So why has this come about, and what can be done to make the income tax system fairer for families?
1979 – 1997
To understand where we are today, we have to go back to the 1980s. At the time when income tax was reintroduced in 1842, social and legal conditions were of course entirely different from what they are today, and it was in the light of the times that the Victorians treated the income of a married woman as that of her husband for the purposes of the tax. However, that remained the rule long after the conditions had changed very markedly, and it was very much a sore which needed to be resolved when the Conservatives were returned to power in 1979.
Personal tax issues were certainly something very much in the heart of Geoffrey Howe, but, hardly surprisingly, he concentrated on removing the excessively high rates of income tax – at the time the top rate of income tax was 83 per cent – and abolishing the investment income surcharge. It was left to Nigel Lawson to tackle the various structural issues which had grown up over the years.
Apart from the treatment of the income of married women, and the lack of privacy to which that gave rise, another problem was that a married couple, both of whom were in paid work or where only the wife was in paid work, got about 2.6 times the single person’s allowance, while a married couple where only the husband was in paid work got 1.6 times that allowance. The treatment of a married woman’s investment income could be quite unfair and impose a penalty on marriage. A single parent or a cohabiting couple with children were broadly in the same position as a married couple with children (without of course the privacy issue), but a cohabiting couple without children was treated less well than a married couple without children, though arguably it was the latter who had too great an allowance rather than the former who had insufficient.
In his Green Paper in 1986, The Reform of Personal Taxation, Lawson sought to tackle these issues in a manner which also raised the tax threshold in a cost effective way so as to reduce the burden on families with low incomes. What he proposed was that everyone should have a tax allowance, whether or not they were in paid employment. To recognise the shared responsibilities of a married couple, when one of the spouses had insufficient income to use all of that allowance, he or she would be able to transfer the balance to the partner. This could be done without interfering with the independence and privacy of each.
Transferable allowances were not introduced however. In his autobiography Nigel Lawson attributed this in part to Margaret Thatcher’s opposition: she did not think this was the best way to help families. She wanted to see child tax allowances reintroduced. There was a worry that transferable allowances would deter a married woman from going back into paid work and there were administrative complications. A couple might not have been able to decide whether to transfer an allowance until the end of the tax year, at a time when (before the introduction of self assessment) the system worked on the basis of minimising the need for personal tax returns. And there were concerns whether the new computerisation system would be ready in time.
In its place we saw the system of independent taxation, which Nigel Lawson announced in 1988 and which came into effect in 1990, under which everyone, whether male or female, married, cohabiting or single, and whether childless or with children, had the same personal allowance. However, in order that most married couples should not lose out from the change, a Married Couples Allowance was introduced equal to the difference between what had previously been the married man’s allowance and the single personal allowance. The Additional Personal Allowance, which single parents and cohabiting parents with children had been receiving, was maintained at a similar level.
As the years went past however, these allowances were reduced in value – in his 1994 Budget Speech, Ken Clarke described them as ‘something of an anomaly’ – before being abolished by Gordon Brown in 1999. After a gap of a year and then the introduction of a rather different system of tax credits, the present system was introduced including provision for child tax credits. In this respect universal credit is not very different.
As a consequence, income tax no longer reflects the size or nature of a family. Inequality has increased and many families have suffered from an effective “top tax rate” of over 90 per cent – higher than the 83 per cent rate that Howe had abolished in 1979. With hindsight it is clear that the Married Couples Allowance and the Additional Personal Allowance were not “something of an anomaly” but, in the absence of a fully transferable personal allowance, they were an essential part of the structure if families were not to bear an increased share of the tax burden. In the 1980s Conservative Chancellors were prepared to tackle the structural problems that had build up over many decades. They now need to tackle the structural problems that have built up over the last three decades. The debate needs to start mow.
2010 – today
As part of the Coalition Agreement the Conservatives accepted a key manifesto commitment of the Liberal Democrats, and it was agreed that priority should be given to increasing the personal allowance from £6,475 to £10,000 ‘to help lower and middle income earners’. George Osborne took this very much to heart and, in line with the Conservative 2015 manifesto, the allowance is being further increased: this year it is £11,850 and it is due to be increased to £12,500 by 2020.
The Treasury has told us that total cost of these increases has been almost £19 billion – a very significant proportion of the cost of all the tax changes made since 2010. Was this money well spent? Popular as the policy has been, very little of the benefit has ended up with families, or even with taxpayers in the poorer half of the population. Indeed, most of the benefit has ended up with taxpayers who are in the top half of the population. The Institute for Fiscal Studies were warning before the 2010 election about the distributional effect and that increasing the allowance to £10,000 would be very expensive.
There are no easy answers. But we should be prepared look at the options that are available and consider in particular whether there is anything that can be learned from other countries. In the meantime, any tax cuts that can be afforded should be focussed on families. Before any sensible reform can be contemplated, there does need to be a much better understanding of which households are well off and which are less well off. The Treasury certainly seems to have little understanding of this.
In 2012, Osborne introduced the High Income Child Benefit Charge. This starts to withdraw the value of Child Benefit when an individual has an income of £50,000. It is fully withdrawn if the income is £60,000 or more, regardless of the number of children for whom the benefit is paid. It applies not only to the recipient of the child benefit him or herself, but also if his or her spouse, civil partner or, in the case of a cohabiting couple, partner, has an income of that level.
In this way it runs fully counter to the principle of independent taxation. Single-earner couples continue to be outraged that they are losing their child benefit, whereas a two-earner couple, each of whom has a good income but less than £50,000, keep theirs. Moreover, it is far from the being the case that an income of £50,000 means that a family is well off. Our work suggests that, when London housing costs are factored in, one-earner families may well need an income of over £50,000 to avoid being classified as being in poverty. If this is correct, the Treasury needs to look more carefully at who benefits or loses from tax changes than appears to be have been the case in recent years.
In 2015, the transferable allowance was introduced for married couples and civil partners (but not for cohabiting couples). But the allowance which can be transferred is only one tenth of the personal allowance and it applies only if the receiving spouse or civil partner is a basic rate taxpayer. Again, new work suggests that couples who are not well-off are denied this allowance. Welcome though this reform is to those of us who argue for a fairer tax system, it is a long way short of Lawson’s original transferable allowance proposal. If that had been adopted, some families in poverty who face four-figure income tax liabilities would not be paying income tax.