Is it time to re-introduce the 10p income tax band?
All things considered, is it time to bring back the 10p income tax band, scrapped by Gordon Brown?
Unique arguments in favour of the 10p tax policy
As outlined above, there are clear arguments in favour of the 10p tax policy in its own right from both economic efficiency and moral perspectives. However, one must compare the policy with cost-equivalent alternatives, such as raising the personal allowance. Then, its desirability becomes less clear-cut.
One unique justification made by Tim Montgomerie for its re-introduction, as opposed to further increases in the personal allowance, is that "We want most Britons to feel the burden of the state's expenditure." This is a variation of the argument of the IEA’s Mark Littlewood, that raising the personal allowance too high protects someone from the tax system such that they have no incentive to vote for fiscal responsibility.
Arguments against the 10p tax policy
The above argument has some merit, yet one could rightly counter that there does not seem to be much morality in taxing people on very low incomes only to hand them back significant amounts in benefits. You could also highlight that the justification assumes people aren’t very aspirational and do not worry about the potential tax burden they would face if their incomes increased.
There are four other reasons to object to the 10p rate policy over a personal allowance increase, however.
First, the 10p rate would add further complexity to the tax system. If it was introduced, we would have moved from an income tax system (not to mention National Insurance) with three marginal rates in the last years of the Thatcher government (0, 25, 40) to five marginal rates (0, 10, 20, 40, 45) now, and six if you include the withdrawal of the personal allowance between £100,000 and £118,880. When the 10p rate was first introduced in 1999, Edward Troup, then Head of Tax Strategy at Simmons & Simmons Solicitors, and now Tax Assurance Commissioner at HMRC, told the Treasury Committee that
"A perfectly simple tax system delivering whatever tax you want to almost anybody can be delivered with personal allowances and two rates of tax".
It’s difficult to see why this should be so different now. What’s more, just after the 10p rate was abolished, Robert Chote (of the Office for Budget Responsibility), in his previous role at the Institute for Fiscal Studies said:
“The 10p band should never have been introduced in the first place. It complicated the income tax system and was poorly targeted on those it was claimed to help.”
Second, the main problem that we envisage is not so much any administrative complexity, but willingness for Chancellors in Budgets to tinker with thresholds for different marginal rates in order to take from one group to give to another. We have already seen evidence of this earlier in this Parliament, with the Coalition government part-funding increases in the personal allowance by lowering the starting threshold for the 40 percent higher rate.
By creating another readily identifiable group of low earner income taxpayers, the policy would therefore accentuate pressure to drag more and more into higher bands, with higher marginal rates, in order to fund so-called ‘fair’ tax cuts for lower income groups going forward.
Third, the addition of another marginal rate makes it less likely that a consensus will be achieved for broad-based tax cuts of the sort carried about by both the Thatcher and Reagan administrations in the 1980s. In particular, it would undermine attempts to move towards a simpler, flatter tax system – particularly if a future government sought to merge fully income tax and National Insurance contributions.
Fourth, the real problem with marginal tax rates for many low income groups is not due to income tax but to tax credit withdrawal. A full review of the tax credit system, with a move to an earned income tax credit like that accelerated in the US under the Clinton administration, would do far more to aid work incentives than the introduction of the 10p for a narrow band of income.
While the universal credit system will help those in the ‘unemployment trap’, for whom work doesn’t pay, more still needs to be done to address the ‘poverty trap’ – that low paid workers can face extremely high effective tax rates as their tax credits are withdrawn when their working incomes increase.
It is good to hear a Conservative MP forcefully make the moral case for lower taxation, particularly for those with low earnings and trapped in relative poverty by the complex interaction of taxes, benefits, and tax credits. Robert Halfon MP has done much good work to trumpet the case for an increased personal allowance (and for preventing hikes in fuel duty).
But would the re-introduction of the 10p tax rate be a wise policy move for the Conservatives to adopt were the finances available for it to be achieved?
Whilst the political appeal is obvious, the economic benefits for the very low paid can be better met by further increasing the personal allowance. What’s more, there are policy risks in the longer term, giving politicians further scope to drag increasing numbers into higher marginal rate bands in the name of ‘fairness’, whilst further complicating the personal tax system.
Ultimately, it would be preferable to focus on further rises to the personal allowance, merging income tax and National Insurance to promote tax transparency. In doing so, we would seek to reform the tax credit system towards an earned income tax credit system with less punitive deduction rates, and try to take people back out of the 40 percent tax band.
Ryan Bourne is head of economic research at the Centre for Policy Studies. Follow him on Twitter @RyanCPS
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