LOW TAXES increase living standards and give people more control over their lives. We have an obligation to help the poorest members of our society who have been let down by “bog standard” public services and declining social mobility.
There seems to be an obvious way of putting together these two powerful propositions — cut taxes for poor people. Maurice Saatchi is the most eloquent exponent of this view. It is rapidly becoming the conventional wisdom. But it won’t work. Trying to pull together two very different propositions just creates an almighty mess.
Many people assume that there is an easy way of cutting taxes and helping the poorest people — we should raise the income tax allowance. At the moment people start paying income tax at about £5,000 a year. What if we increased that to £10,000 a year — wouldn’t that transform the situation of the poorest people?
It is true that poor people pay a shockingly high amount of tax. The richest 20 per cent of households lose 35 per cent of their incomes in tax. The poorest 20 per cent of households lose 37.9 per cent of their incomes in tax. In fact the poorest 20 per cent pay a higher proportion of their incomes in tax than any other slice of the population. No one seriously planned for this bizarre outcome.
But the tax that poor people pay isn’t income tax. The poorest 20 per cent of households sacrifice 28.5 per cent of their income in indirect tax, of which the biggest single item is VAT. All direct taxes take 9.5 per cent and of this the biggest item is council tax, which takes 4.6 per cent. Income tax, taking 3.5 per cent of their income, is responsible for less than one tenth of the taxes paid by the poorest fifth of households.
Advertisement
If we really wanted to cut the taxes poor people pay we would be looking at indirect taxation. But big cuts in indirect tax would be very expensive. And if they were financed by increasing direct taxes, we would undermine incentives to work. That may be why I don’t detect a great desire in any political party to reopen issues such as the rate of VAT.
There is a second big problem with raising the income tax threshold as well. Increasing the threshold cuts the tax bill for everybody who is on income tax. It takes some people out of income tax, but it is worth most to people who are still paying income tax and get the full benefit of the higher threshold. When I asked the Treasury last year how much it would cost to raise the personal tax allowance to £10,000, for example, it estimated the cost at £30 billion. Of this, only about £2 billion was spent on people who are taken out of tax altogether. The bulk went on the rest of us, who all gain from higher tax allowances. So raising the personal tax allowance costs an awful lot of money because it helps almost everyone. And it is worth least to people on low incomes who don’t get the full value of the policy.
Some people believe this is still worth doing because it would get people off Gordon Brown’s tax credits. It is assumed that people on modest earnings are paying as much in income tax as they are receiving in tax credits. If this were true, I would leap at the opportunity to tackle this problem. I have no brief for Mr Brown’s tax credits. They are complicated. Reports out this week show the distress caused to millions of families by their shambolic introduction. I would like to see them reformed.
But the amount of money that a low-income family is receiving in tax credits is much greater than the amount they are paying in income tax.
If you are earning £10,000 a year you might be paying £900 a year in income tax but receiving, depending on your family circumstances, several thousand pounds in tax credits. No affordable increase in the personal tax allowance will offset most low-income families’ tax credit entitlements.
Advertisement
My conclusion is that we should reform our tax system and help poor people. But these are different problems requiring different solutions.
We should reform the tax system so it is less complicated and intrusive. We need a simpler tax system — trying to use tax to do the job of the benefits system makes it far too complex. We should challenge Gordon Brown’s ever-expanding stealth taxes. We need to look at the way our tax system hits businesses. We should look at tax reform that rewards saving.
Poor people in our society have been let down by appalling failures of policy. The benefits system needs reform. The standard of education on our deprived estates needs to be higher. We should make it easier for people to build up savings and buy their own house. They lose out most from the failure to ensure law and order on our tough estates. We should once more be committed to breaking the cycle of deprivation of which Keith Joseph spoke eloquently 30 years ago.
So yes, there is an exciting agenda for tax reform as part of making our economy more flexible. And there is a desperate need for fresh thinking on how we help the poorest people in our society. These two principles, a flexible economy and a strong society, must be at the heart of our agenda for renewing this country. But they are different principles. You can’t just get social justice via tax cuts.
And anyway, it isn’t just a matter of money. It is about opportunity, mobility, and transforming the quality of our neighbourhoods. It’s about supporting successful voluntary groups. It’s time to think rigorously about this, for only if we do can Britain become a stronger society.
Advertisement
The author is a member of the Shadow Cabinet