A £12,500 personal allowance: a primer

Raising the personal allowance has been a key fiscal policy objective of the coalition. David Cameron has just announced a future Conservative Government would raise it from £10,500 (to be introduced in 2015-16) to £12,500. What might this cost, who will benefit, and who is it targeted at?

The cost:

Here are some very rough back of the envelope calculations. When, in Budget 2014, the Coalition announced the raise to £10,500 (from, assume, £10,000), this was forecast to cost an average of £1.75bn pa over each of the next four years. Multiply that by, roughly, four (if 500 costs £1.75b than 2000 all things being equal will cost four times as much) gives you £7bn pa – but of course you then have to factor in the fact that as the personal allowance increases the number of people able to take advantage of that increase declines (because they earn less than the increased allowance). About (these percentage figures only cover people with some liability to income tax) 11% of people earn below £10,500 and about 21% below £12,500. And that fact is a rather telling one – I’ll come back to it.

Who benefits:

The first thing to note is that it only benefit those earning more than £10,500.

If you work part-time, or you’re self-employed, or you work on a zero-hours contract you may well benefit not at all. Self-evidently, if you don’t have taxable earnings – because for example you’re reliant on benefits – the increase will do nothing for you.

What about those on the minimum wage? £6.50 per hour x a 35 hour week gives you a weekly taxable income of £227.50 or an annual income of £11,830. So if you earn minimum wage, you’ll benefit. Somewhat. To the tune of £266 per annum post tax. Those earning the median wage (something around £520 pw), on the other hand, will benefit by £400 pa. (These figures assume that there are not corresponding rises in national insurance contributions thresholds – although past practice suggests there will be).

Who is it targeted at?

The short answer is, not the lowest paid. If you wanted to help only those earning minimum wage, you could certainly do so an awful lot more cheaply and an awful lot more generously than by this measure (which is likely, depending on the detail, to benefit everyone earning below £100,000).

Remember that when you hear a politician say, in response to the question: ‘What have you done to lift people out of poverty?’ the answer ‘I raised the personal allowance to £12,500 and took a whole bunch of people out of personal income tax’.

24 thoughts on “A £12,500 personal allowance: a primer

  1. An excellent point.

    The transferable personal allowance for married couples and civil partners which comes in next year does help some low income families, and perhaps with this proposal the amount that can be transferred should rise but of course this adds unwelcome complexity for those on very low incomes.

    However, individuals with income of only £10,000 are currently bearing £245 in employee NIC if that income derives from a single job (rather than multiple part time jobs). So rather than extending the personal allowance, there is an argument for gradually increasing the NIC threshold instead. This is hugely expensive because the employer threshold should really rise similarly, but if we did away with employment allowance and used that money and the offer of £12,500 additional funds we might be able to do a little there, which would really benefit the poorest. Last time I heard ££’s I was told that increasing NIC threshold to £10,000 would cost of the order of £12bn….

    Backtracking a little – if those on really low incomes have multiple jobs, then maybe the tax threshold is the place to spend the money?

  2. A generous negative income tax would be far more efficient and effective in assisting those with low or no incomes to take responsibility for their lives and with lifting them out of almost abject poverty. With such a system there should be no need for “social security” benefits and the paternalism, conditionality and means testing that accompanies them. Freedom and egalitarianism are made possible with a thoughtfully designed negative income tax system.

    Radical? Yes! Self financing? Could well be. Technically feasible? Yes..Politically feasible? Certainly not with Osborne as chancellor.

    Now if only Labour could get radical….

  3. Might there be such a thing that you made earlier? Here, for example?

  4. I will add Practically feasible? …… Waaaaay out there I am afraid. Radical, fascinating, chances of getting it off the runway as close to zero as makes no difference.

  5. I’m afraid that was my conclusion too…

  6. Surely the simpler option would be to increase the minimum wage, so that people in full time work didn’t require in-work benefits? *ducks*

  7. Where is that IFS graph of effective tax rates as a function of income?

    Currently (and ignoring employer NICs for a moment) we have in effect a zero percent rate of employment taxes on the very lowest paid (negative surely, if you include benefits), then a 12% “starting rate”, then a 32% lower basic rate, and then a 42% upper basic rate (with 62% spike) and then a 47% additional rate.

    So without NICs changes, this proposal is simply about widening the band that qualifies for the 12% rate rather than the 32% rate. To help the very lowest paid, you need to provide benefits or tax credits or a citizens income or similar, and then do something about the lower NICs threshold.

  8. I might point out that in 13 years in office Labour (who you support) raised personal allowances from £4,045 to £6,475 (having taken 9 years to increase it by less than £1,000).

    Sure we are where we are today but no credit at all for the coalition personal allowances policies? I’d expect that on SOME tax blogs but not yours

    You did say you wanted a bit of balance.

  9. I’m fairly amenable of many criticisms; but distributing my critique of political parties unfairly is not, I think, one of them. You need to read my blogs of last week during Labour Party Conference.

  10. In fact, my own thoughts are apolitical, apart from concern for fellow travellers on the road of life. But what does worry me is unworkable announcements (not that this is one of them) or things that won’t achieve their stated or implied objective in a cost effective (from an administrative perspective) and simple way. My passion is for a workable tax system, well understood by taxpayers, and as slick and effective as possible.

  11. Have thought a little more about your comment.

    I don’t think my post is political at all. It makes some narrow points – which no one seems to be doubting – about the distributional impacts of this hugely expensive policy.

    Given the focus of the post, I also don’t think it’s fair to say I ought to have considered the Conservatives record as a whole.

    That having been said, I’m very happy to be challenged on this stuff. Inevitably, there will be occasions when those challenges are right. Just not this one.

  12. “I also don’t think it’s fair to say I ought to have considered the Conservatives record as a whole.”

    Point of order. It’s the Coalition. 🙂

    I suppose my comment was most driven by the last part of your blog about the politiician talking about lifting people out of tax. Since 2010 a lot of people HAVE been lifted out of tax. Looking at one year in isolation can’t give a clear picture of a long term policy. Had the Coalition raised Personal Allowances to £12,000 the day they came to power and then frozen them, would you now be criticising them for not having raised them for 5 years?

    Your blog criticises a policy but doesn’t offer an alternative which is an easy stance. You hint (I think) at raising the NMW but a call to raise the NMW to (say) £8 an hour could be criticised as doing nothing for those already earning £8 an hour.

    Is there any policy that couldn’t be criticised if you looked at it narrowly enough?

  13. There are some points to be made in favour of asking even the lowest paid to pay some tax on their income – that is, to make a small contribution towards the public expenditure; so it is clearr that we are all in it together.

    Yes, of course everyone pays other taxes such as VAT and so on, but compare, for example, some car drivers who unjustifiably claim priority over cyclists because they pay their road tax (even though there is no such thing as road tax, vehicle excise duty is not hypothecated, road-related expenditure is not covered by VED alone anyway, cyclists often own cars too, and pay other taxes too, etc).

    You can of course provide benefits equal to or greater than the tax paid.

  14. I very much agree. If you don’t see a little coming out of your pay packet, you’re amenable of the criticism that you’re talking your own book when you say you think taxes should be higher. You may think it’s right; I may think it’s right; and Margaret Thatcher certainly thought it was right, but… It was (as I recall) her insistence on the point in the structuring of the poll tax that led to the poll tax riots, and ultimately her departure from Government. I guess that’s why we’re not – well I’m not – ever likely to achieve elected office.

  15. As the Personal Allowance gets ever higher, I wonder where we are going with National Insurance and the State pension. The Personal Allowance shoots up, the NI Primary Threshold tries to keep up but the LEL has to lag further and further behind to prevent the low paid from losing qualifying contribution years.

    It’s a worthy concept that more and more people paying neither tax nor NI can qualify for the State Pension but I do wonder how sustainable that is.

    In looking for a solution, can I suggest we don’t start from here?

  16. I may be a cynic, you may take whatever view you wish. In my experience though people do indeed talk their own book regardless of having a personal buy-in or not. Colleagues at work tend to equate wealth with salary, which is probably a good working definition for most people. Their idea of ‘rich’ is invariably somebody earning just slightly more than and amount to which they believe they can realistically aspire. And accordingly the rich should always pay more. The driver taking an aggressive attitude towards the cyclist just wants the road; his vehicle excise duty is a handy crutch to lean on for justification.
    so I am disinclined to accept the notion that even the poorly paid should carry the burden of some Income Tax (which is what you mean here). I cannot see imagine that seeing tax being taken from a.person’s pay packet as opposed to paying Council Tax or knowing that the weekly shopping bill includes VAT provides him or her with a stake in the system that is otherwise absent.

  17. Taking the very low paid out of tax, and at the same time increasing the level of income at which means tested benefits are provided surely makes sense, as it takes us away from the “give with one (expensive) hand” – benefits and “take with the other (expensive) hand” – tax (and I include NIC). That means less state costs to be borne by all taxpayers, and a lot more transparency. So in the interests of a cheap to run but really effective system that has to be the right way.

    The question really is when to stop, and how to deal with the inevitable benefit of raising the starting point of tax for those who have not “paid” by reduced access to state benefits.

    Doing what we have been recently by taking it off the top end of the basic rate is counter productive. You push more taxpayers into higher rates, which then to operate the tax system properly become very expensive. Collecting the odd bit of 40% (and 32.5%) when the system itself is predicated on basic rate taxpayers (tax deducted from interest, tax credit on dividends) gets awfully expensive, as the only proper way to do it is bring them all into self assessment. Which will cost more than it collects. So in the interests of efficiency you “ignore” a few pounds here and there, and hey presto, an optional tax system……

    When the basic structure of the income tax system makes income tax too expensive to collect (and I am absolutely not suggesting that HMRC would do as I have indicated above) there is something very wrong with the rate bands. So is the increase in the width of the basic rate band a bad thing or a good thing? In reality all taxpayers benefit due to the cost savings. But it obviously has heavy political overtones, which is of less interest to me, and much greater interest to those who want to make a political point one way or another.

    What would be really useful would be an internal cost saving estimate to offset the exchequer loss so that we can really see how the design of the tax system affects the tax take.

  18. Thanks Rebecca for your post.

    Some very interesting thoughts there. There certainly seems to be lots of scope to improve our – certainly my – understanding of the functional operation of our tax system. The relationship between tax and yield changes – which you highlight – is one important aspect of that. And although the string was swiftly cut on the PAC’s kite flying of reliefs as tax expenditure, I still remain extremely interested in whether we adequately track what reliefs cost up. Blog post someone? And transparency and accountability would also be improved by better quality TIINs.

    One day, one day, I will have time to blog about these really fascinating questions.

  19. Yes, clearly it is more efficient not to collect tax, than to collect it with one hand and hand it back with the other. And yes, people almost inevitably want someone else to pay more tax. I am not suggesting that the poor should “bear the burden of tax”; just that there are reasons why it makes sense for everyone to make a visible contribution.

    On the “cost” of reliefs, there is the philosophical point about whether they actually “cost” anything (and if so, who). It depends on which end of the telescope you look through. Providing a tax relief tends to mean that the government decides not to collect some tax – that is, the taxpayer keeps the cash that belongs to them, rather than being compelled by law to hand it over. That is only a “cost” if you think the money belongs to the government in the first place: that the government is giving something back to the taxpayer something that would otherwise belong to them. (Or, if revenues are maintained, if the burden of the taxes foregone is passed on to another taxpayer else.)

    There was the NAO report on tax reliefs earlier this year: https://www.nao.org.uk/report/tax-reliefs/

    As I recall, the total tax take is about 30% of GDP. Without any reliefs (including personal allownace, etc) taxes would take another 20% of GDP. From some earlier notes, here are the “costs” of some of the largest reliefs:

    * income tax personal allowance – £68.5bn
    * secondary NICs threshold – £23.6bn
    * income tax pensions exemptions – £22.8bn
    * capital allowances – £21.0bn
    * primary NICs threshold – £20.2bn
    * IHT nil rate band – £18.4bn
    * VAT zero rate of food £15.8bn

    As Joylon says, most of the benefit of an increased personal allowance and higher 40% tax threshold do not go to the poorest, but those further up the income scale. UK median earnings is about £25,000.

  20. Thanks Andrew. Fair points all. As always with these things, you need to start by identifying your counterfactual. Which I didn’t do – or perhaps more accurately only did implicitly. If one’s counterfactual is the tax take without the relief, then the ‘cost’ (to the fisc) of the relief is the reduction in the tax take occasioned by it.

    Let’s put aside matters of political art and describe that (just for the sake of argument) as a cost. I find the idea that (as I understand it) that cost is not routinely tracked by HMT, or reported to the public, troubling. How can we assess whether that cost delivers a matching or greater value unless we start by knowing what the actual cost (as opposed to what are sometimes rather vague and unsubstantiable estimates in TIINs) is?

    A number of similar points can, of course, be made about raising taxes. And it was one of those points that I understood Rebecca to be making.

  21. May I raise (I hope) a good natured challenge to Rebecca?

    You are doubtful that a negative Income Tax is viable as a practical measure in any timeframe we can see. Speartely you also point out the absurdity of tax credits being handed out by government with one hand and reclaimed via IT and NIC with the other – I wholly agree.

    However, if tax credits end at or before the level of PAs or NI threshold, haven’t we then in effect achieved a negative income tax arrangement?

  22. Ironman, I agree absolutely, and indeed so does Gordon Brown, who in the early days of Working Tax Credit described it as such, to the dismay of the OECD. In fact we now have a form of negative income tax right up to the point that the tax paid exceeds the benefits paid to the individual or family, which is quite a lot higher than the entry point to tax, but the OECD insisted that it was described as benefits rather than negative tax.

    My comments about “wouldn’t fly” were more to the detail of the significantly more radical suggestion made by the Uxbridge Graduate, which is linked in Jolyon’s post of 2.10pm on October 1st.

    We are in accord – but I wish we were not in this position! Think of all the wasted money!

  23. We have circled round this wagon many times – anyone remember Mirrlees? I really think a key step is to look for genuinely transformative changes, not more tinkering around the edges. Things like abolishing NICs (ducks for cover) as it causes far more problems than the revenue it raises. (We could think about transitional measures, such as increased PAs for older people who currently do not pay, tapering over say 30 years.)
    We could deem state pensions to be paid under deduction of (non-refundable) basic rate tax. Or see if Universal Credit really is a hopeless morass into which we throw Permanent Secretaries as sacrificial offerings.

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