David Cameron’s ‘middle-class tax giveaway’ in reality means giving huge amounts of cash to the very richest argues James Meadway

David Cameron offered two headline-grabbing proposals at the Conservative Party conference last week:

• moving the threshold for the payment of any income tax from £10,500 to £12,000.
• moving the threshold for the higher 40p rate up from £41,900 to £50,000.

Both will be enacted over the lifetime of the next Parliament, should the Conservatives be returned to office – at a total cost of £7bn per year according to the Institute of Fiscal Studies (IFS).

A higher tax threshold means little to our lowest paid

The move has been portrayed as a boost for both the lowest-paid, and for ‘middle class’ earners currently falling into the higher rate category. But because of how the tax system works, this is not the whole story.

Above the tax thresholds, every £1 of income earned is taxed at that rate. But every £1 earned below the threshold is taxed at the lower rate – or even not taxed at all, below the bottom threshold. This means that everybody earning above a threshold also benefits when the threshold moves up.

The problem is that 17% of workers already pay no income tax, because they earn less than £10,500 (the bottom threshold). So the movement in the lower rate threshold will benefit the lowest-paid relatively little. Analysis by the IFS earlier this year suggests that 69% of the money given away would go to workers in the top half of the income distribution. Just 15% would go to workers in the bottom half.

Moving the top rate threshold is more obviously regressive. Anyone earning over £41,900 a year is already in approximately the top 15% of the population. At £50,000 a year or above, they will be in the top tenth of society. The median (middle) income in the UK is £27,000 a year.

Because of this, changing the higher rate threshold overwhelmingly benefits the wealthiest section of society. The top 5% will gain well over £2,000 a year from the changes, while the effect across the rest of society will be minimal – people simply do not earn enough.

The real story on the deficit

Closing the fiscal deficit – the gap between what government spends and how much it gets in taxes – has long been a key economic goal of the Coalition government.

Yet since the start of this year, the UK deficit has widened. This is despite our return to economic growth, which might be expected to increase the taxes being paid to the government. Over April-August, the deficit was £45.4bn, compared to £42.8bn the same time last year.

The government’s own Office for Budget Responsibility (OBR) expected tax receipts to increase by 5% this year. They have increased by only 3%.

The reason for this is straightforward. The only significant rise in tax revenue since the recession has come from Value Added Tax (VAT) on goods and services, which has increased 32% since the recession. The amount of income tax paid by individuals, on the other hand, has stayed the same, while the amount paid by corporations has actually fallen 14%.

Corporation taxes have been repeatedly cut by the government, so it is no great surprise tax receipts from businesses have decreased despite a significant rise in corporate profits.

The reason that income tax has not moved is because most people’s real earnings have barely moved – despite the alleged recovery. Real median wages and salaries are down 10% since 2008, the biggest fall for generations. And despite record numbers now moving into self-employment, receipts from self-assessed income tax (as paid by the self-employed) are well down on 2008. Falling tax receipts from self-employment strongly suggest that the collapse in self-employment earnings has continued.

The underlying picture, then, is of a weak economy – one that is not capable of closing the deficit by itself, and that certainly cannot bear the strain of further tax cuts without ever more damaging cuts to public spending.  The ‘recovery’ appears to be strongly favouring the wealthy, with the proposed tax cuts to add still more to their wealth.

Glossary:

• Fiscal deficit: the gap between what a government gets in taxes, and what it spends. (Sometimes just “the deficit”).
• Regressive taxation: when the richest pay proportionately less than the poorest. The opposite of progressive taxation
• Tax threshold: the boundary over which income is taxed at a higher rate
• Median incomes: a way of measuring the average that finds the person right in the middle of the distribution. This is a better measure than the mean, since it accounts for inequality
• Mean: the conventional average – add up the incomes, and then divide by the number of people

Further reading:

• Bloomberg, ‘Britain’s budget deficit widened in August in blow to Osborne’, 23 September 2014
• Financial Times, Off Message blog, ‘Tax cuts for all – but more for you!‘, 1 October 2014
• Huffington Post, ‘Tax cuts for the rich? 4 graphs David Cameron does not want you to see‘, 1 October 2014
• Flipchart Fairy Tales, ‘The taxless recovery‘, 26 September 2014