Asking older people to contribute to tackling the deficit and shoring up the country's tax base in the long-term is not unreasonable.
By Richard Darlington
Older people have been relatively protected from the spending cuts so far. The young are the ones who have taken the brunt of the pain, seeing an end to their educational maintenance allowances and the scrapping of the Future Jobs Fund. Youth unemployment has topped a million, the highest since records began. Working families have already seen their budgets stretched as tax credits for low earners are frozen and support for childcare reduced. Many older people enjoyed windfall gains from the house price boom that has priced many younger families out of the market.
Asking older people to contribute to tackling the deficit and shoring up the country's tax base in the long-term is not unreasonable. This is particularly true if we bear in mind that only a fifth of pensioners are poor – retirement no longer means the life of poverty that it might have a hundred years ago when the higher allowances were introduced. But the chancellor's 'granny tax' was presented as a 'simplification' rather than a national sacrifice.
Removing the age-related allowances makes sense because, on average, it takes much more from better off pensioners. It is true that the wealthiest fifth of pensioners do not lose much. They are not entitled to the higher allowances, which are reduced as income rises above £24,000. But IPPR analysis shows that the poorest fifth also lose very little. Most have incomes below the allowance so will not be affected by the freeze. The biggest losses will be felt by the second richest fifth of pensioner households (those in the 4th income quintile). They are more likely to have two pensioners with incomes above the allowance but below the income limit.
It wasn't supposed to be like this. The government wanted a political focus not on the £1 billion they have taken from pensioners but on the £3.3 billion they have given to lower earning tax payers. From next April, the personal allowance rises to £9,205, generating a tax cut of £220 for all basic rate taxpayers earning more than the current allowance of £8,105. The Liberal Democrats have lobbied hard for this move as part of their "fairness" agenda, arguing that the higher allowance lifts 840,000 low earners out of income tax altogether. At the other end of the scale, part of the gains for higher rate taxpayers have been restricted, which helps to offset the cost.
Nevertheless, this remains an expensive measure. Any tax cut spread across 24 million taxpayers will be expensive if it is to have a significant impact on individual incomes. So was this the best way to spend £3.3 billion when money is so tight?
Two points about the higher personal allowance suggest it was not. First, the struggling economy is crying out for a quick and temporary stimulus to boost consumer demand, which raising the personal allowance fails to deliver. The increase will not come into effect until next April, but with unemployment at a 17-year high and rising, we need a boost now, not in 12 months' time. The higher threshold will be permanent (and very likely to increase even further), eroding the UK's tax base in the long term when the future pressures on public spending mean we should be doing everything we can to protect tax revenues. An immediate but reversible cut in the main rate of employees' national insurance would have been much more effective.
Second, the Liberal Democrats' assertion that a higher personal allowance represents "fairness" in the tax system is open to question. A higher personal allowance is progressive across individuals because it gives most basic rate taxpayers a flat rate amount. But across families, the change is less clearly progressive, with families in the middle of the income distribution gaining the most in relative terms.
This is because these families are more likely to contain two taxpayers, so they get double the benefit, while families towards the bottom of the income distribution are more likely to have adults who are not working or not earning enough to benefit from a higher tax allowance. Someone working 25 hours a week on the minimum wage (£6.19 an hour from October 2012) earns less than the existing allowance so will not see any gain when the tax threshold rises.
Richard Darlington is head of news for IPPR.
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