The low-paid get a lot of words from politicians. Here’s a plan to give them higher incomes.
Getty

Across the developed world, there has been increased focus on the recent miserable income experience of millions of low to middle income working families.  This discontented group is variously said to be behind the rise of Trump in the USA and the shock Brexit vote in the UK (in reality, the link between income growth and political radicalism is less clear cut – as those income rich pensioners who voted to leave the EU demonstrated).

Governments claim to be prioritising the interests of “hard working, low earning” people and Britain’s PM, Theresa May has even invented at least two names to describe them: first, “JAMs” (the Just About Managing) and, more recently, the “OWFs” (Ordinary Working Families).

It is unsurprising that politicians are focusing on the needs of this large group. Their earnings have stagnated over a sustained period. In the UK, for example, low to middle income working households have experienced no growth in real incomes since 2003 – according to the Resolution Foundation1.

What is more surprising is that all the political focus on this issue has resulted in almost no concrete policy actions. Indeed, in the UK, recent steps to raise the minimum wage have been more than cancelled out by larger cuts in welfare benefits (see that same Resolution Foundation report for details).

What explains this gap between benign rhetoric, and benign neglect? Perhaps it is a matter of political bandwidth? May’s government is preoccupied by the complexities of Brexit, while Trump is hardly short of political challenges, from North Korea to healthcare reform. But given the scale of this economic and a political challenge (and with many votes at stake), it’s hard to regard political bandwidth as a sufficient alibi. Most governments can do more than one thing at a time.

Perhaps a lack of deliverable policy solutions is the real issue? In both the US and UK, the lack of productivity growth appears a central part of the problem, but the solutions – investment in human and physical capital – are necessarily long term in nature.

Meanwhile, in a continuing era of public sector austerity, governments struggle to pursue any remedies that carry a price tag. When Mrs. May’s Conservative Party presented its recent General Election manifesto, the search for more savings led them to propose policies which would actually worsen the position of lower income working households (such as scaling back entitlement to free school meals).

Some policies seem to fail both affordability and desirability tests. Paying out more money in means-tested tax credits can, for example, undermine work incentives2.

Raising the personal income tax threshold has lifted 2.6 million lower income Britons out of the income tax system but it's no longer such a progressive policy because it increasingly benefits double income families who tend to be better off. Picture credit: Nick Ansell/PA Wire/PA Images.

One policy which the UK government has been pursuing since 2010 and continues to pursue – that of raising the starting point for income tax – might help. Since 2010, the UK “personal allowance” has been significantly increased, taking 2.6 million low earners out of the income tax system and delivering a tax cut worth around £600 per year for each basic rate taxpayer3.

The problem with this policy? It isn’t cheap. Moreover, as the allowance is raised it becomes a blunter instrument to target the lower earners. Only 57% of UK adults now pay income tax, and further increases in the allowance will significantly benefit two earner couples (often relatively well off) and pensioner households (as the personal tax allowance has now caught up with the pensioner threshold).

Nonetheless, there is surely more that could be done to reduce the tax burden on low to middle income working households, without damaging work incentives? After all, the UK tax system is hardly generous to lower income groups. The progressivity of the income tax system (where the richest fifth pay 23% of their gross incomes in tax, while the poorest fifth pay just 11%) is still fully offset by the regressive nature of the indirect tax system (where the bottom fifth of households pay 27% of their disposable incomes in tax, versus 14% for the richest)4.

The progressivity of Britain's income tax system (where the richest fifth pay 23% of their gross incomes in tax, while the poorest fifth pay just 11%) is still fully offset by the regressive nature of the indirect tax system (where the bottom fifth of households pay 27% of their disposable incomes in tax, versus 14% for the richest)

Lower income groups pay a particularly large share of their incomes in council tax (which helps fund local government). For the bottom fifth of households, council tax is actually a considerably larger burden than income tax – and accounts for over half of all their income related taxes5.

Council tax has fallen in real terms over recent years, largely because of repeated freezes as part of government policy, but it rose dramatically faster than inflation before 2010.  Council tax is set locally, but the relationship between the level of charges for houses of different values is set nationally. The lowest council tax band (A) has to charge 67% of the Band D amount. Meanwhile, a multi-million pound property in top band G can only be charged at double the Band D amount. Council tax is therefore a regressive tax.

The very lowest income households (often non-working) will receive council tax benefit – potentially paying almost nothing. So reductions in council tax focused on lower income working households would be highly effective in targeting exactly the groups which politicians say they want to prioritise. This could be achieved, for example, by cutting council tax by 25% for lower banded properties. More radically, the Mirrlees Review6 recommended that council tax should be transformed into a simple percentage of property value. Either way, the lost revenue could be recovered by hiking the rates for the largest properties or shifting the tax burden onto higher income groups (see below). This seems a more sensible approach than that favoured by some UK political parties, which have proposed an entirely new “Mansion Tax” on high value properties.

In his forthcoming budget Philip Hammond should reduce the share of council tax paid by households living in lower rated bands. Credit: Neil Hanna, PA Images

How else might low/middle income working households be effectively supported? Well, although the starting point for paying income tax has been raised, this has not been the case for another, less visible, tax – national insurance contributions.  While Mrs. May’s government has pledged to raise the income tax threshold to £12,500, the national insurance starting point is presently around £8,200. Raising this threshold would therefore be a more effective way of targeting support on lower-paid workers, and because employee NI contributions are not paid by pensioners, this “giveaway” is also better targeted.

But how can all this be paid for? An obvious answer would be to raise the higher rates of both council tax and national insurance contributions.

But if the government does not want to raise council tax for larger properties or national insurance for higher paid workers, there are many other possible revenue sources which would avoid hitting low and middle earners…

  • How about reducing the capital gains tax exempt amount?
  • Or cutting back “Entrepreneurs relief”, which the IFS regards as “complex, distorting and arguably unfair”7.
  • What about greater alignment of dividend taxation with income tax, or cancelling part of the reduction of corporation tax rates (the 2010-2015 Coalition government spent almost as much reducing corporation tax as raising the personal allowance – 8)?

The point is that if governments really want to make a difference, they have plenty of workable and immediate policy levers.

One final point: the present UK government has imposed a freeze on most benefits – cutting them significantly in real terms. This policy seems in part aimed at improving the work incentives of those not in employment. But around £1 in £5 of the incomes of “low and middle income working households” come from benefits. This includes housing benefit – as almost 30% of this group now rent privately – up from just 11% two decades ago 9.  This has two implications: firstly, that the government needs to re-think the impact of its benefit cuts on these families; secondly, we need more affordable homes to buy.

Longer term policy should prioritise better education and skills training, improved housing supply and affordability, and productivity enhancing infrastructure investments. But governments are judged over the short and medium term.

It’s surely time for ministers to turn the rhetoric about hard-working but low-paid workers into practical action. In the UK, the Chancellor Philip Hammond has an opportunity to blaze a trail in his Budget on 22nd November – he could start by slashing national insurance contributions and council tax for “ordinary working families”.

David Laws writes for “UnHerd”. He was MP for Yeovil from 2001 to 2015, and was Chief Secretary, Schools Minister and Cabinet Office Minister in the 2010-2015 Coalition government.

His Coalition Diaries, 2012 to 2015 have just been published by Biteback.

Footnotes
  1.  “Still just about managing” – the Resolution Foundation’s general election briefing of May 2017.
  2.  Stuart Adam and James Browne, “Redistribution, Work Incentives and Thirty Years of UK Tax and Benefit Reform”, Institute for Fiscal Studies, 2010
  3.  “The Coalition Government’s Record on Tax” published by the Institute for Fiscal Studies in March 2015
  4.  “Effects of taxes and benefits on UK household income; financial year ending 2016”, April 2017, published by the Office for National Statistics
  5.  Same source as above
  6.  “Reforming the Tax System for the 21st Century: The Mirrlees Review“, Institute for Fiscal Studies, September 2011
  7.  “Taxes and Benefits: The Parties’ Plans”, published by the Institute for Fiscal Studies, April 2015
  8.  “The Coalition Government’s Record on Tax”, Institute for Fiscal Studies, March 2015
  9.  From the Resolution Foundation’s “Living Standards Audit” of July 2017”

Continue Reading

To continue reading for free please sign up or log in. We promise not to overload you with emails!

Stay ahead of the Herd

Get the best of UnHerd in your inbox with our weekly digest