Iain Mansfield is Director of Research at Policy Exchange
Now that the dust has settled, what can we say about the Budget? The Chancellor has given with one hand and taken away with the other.
On the positive side, with little fiscal headroom to play with, he has succeeded in delivering some meaningful change. As Policy Exchange had been arguing for, he cut National Insurance to make work pay, strengthened share ownership to support the property-owning democracy, and reformed the High Income Child Benefit Charge to support families.
In a difficult period, coming after the twin crises of lockdown and the energy shock, we should have no doubt this will make a real difference to hard-working families on the ground. An additional £900 for a typical worker, over £2,000 for a family with two children where the top earner earns £60,000 a year – these are not small sums.
Yet it is also true that this was not a Budget that will solve the UK’s long-term prosperity challenge. Our country’s economic growth is held back by a long-term trend of low savings and investment, too high a ratio of tax to GDP (and the overall tax burden is still rising), and a sclerotic planning and regulatory system that stifles house-building, infrastructure, and both private and public investments.
Critically, it also does not grapple with the urgent need to bring public spending under control, and to reduce the demands upon the state.
But it is when considered through the lens of tax reform that the Budget was of most significance: taking an important first step towards reforming the critical issues in Britain’s system of personal taxation.
In addition to the overall rate of taxation being too high, Britain’s current tax and benefit system suffers from three major structural problems:
- High marginal tax rates and cliff-edges that deter people taking on work;
- An anti-family bias, which deters family formation and makes it harder for people to have children;
- Too great a difference between the rate at which earned income, and unearned income – particularly pensions – are taxed.
There is strong evidence that what matters most to people’s propensity to take on more work, or higher paid work, is not the overall tax rate, but the marginal tax rate. As the chart below shows, the UK tax system is notorious for its strange cliff-edges and absurdly high marginal rates at relatively low incomes – and with 5.6 million people on out-of-work benefits, that matters.
In practice, for many people, the effective marginal tax rate is even higher. The chart does not account for student loan repayments (an additional nine per cent for graduates earning over the repayment threshold), the withdrawal of Universal Credit, or the full withdrawal of childcare support at £100k – which causes someone getting a pay rise to actually be worse off.
A similarly unfortunate phenomenon occurs at the other end of the spectrum, in which Carer’s Allowance is withdrawn in its entirety the moment a person has an average net weekly income of over £139 a week.
At the same time, as set out in Policy Exchange’s report Taxing Families Fairly, the system is brutally indifferent to the needs of families. Unlike many other democratic European nations, such as France, taxation is done on an individual, not a household basis – meaning a household with two children on an income of £30,000 would pay no tax in France, compared to (typically) £3,250 in the UK. Meanwhile, the ‘marriage penalty’ penalises couples on benefits who choose to move in together and get married.
A particularly egregious element was the removal of child benefit in cases where one parent earns over £50,000. Not only did this create the absurd situation where a single mum earning £50,001 received no child benefit, but a two-income household, where both parents earned £49,999, received the full amount, but it created an eye-watering marginal tax rate between £50,000 and £60,000: 71 per cent for a family with three children, or 80 per cent if they were paying off a student loan.
Why bother to take on that promotion – or to up your working hours after having children – if you only keep one pound in every five?
A budget for change
In this Budget, and the preceding Autumn statement, Jeremy Hunt has taken important first steps to addressing all of these issues.
Reducing National Insurance from 12 per cent to eight per cent directly reduces the marginal rate of taxation on basic rate taxpayers from 32 per cent to 28 per cent – an important incentive to work. Equally importantly, by targeting National Insurance, rather than income tax, the Chancellor is reducing the taxation gaps between earned income, on wages, and unearned income on pensions.
The historic decision to charge income tax, but not National Insurance, on pensioners creates a highly distorting effect. This is simply not economically rational: a tax on work is a tax on jobs is a tax on growth. Hunt’s suggestion that this could be the first step towards the wholesale abolition of National Insurance is even more welcome; while expensive, at £40bn a year, it is not out of the question if considered as an objective to be achieved over the whole of the next Parliament.
The changes to child benefit also reduce marginal tax rates. While the raising of the threshold from £50,000 to £60,000 is the most obvious gain, the decision to double the taper period is equally significant. It reduces the marginal tax rate for a parent with three children from 71 per cent to 57 per cent – still high, but considerably better.
Even better, the decision to, by 2026, move to a process of household assessment will end the absurdity whereby some households receive no child benefit while others, with a considerably higher household income, receive it in full.
These reforms have the potential to set the blueprint for a genuinely revolutionary tax-reforming manifesto – one that would commit to fundamentally reforming the UK’s personal taxation system by abolishing National Insurance, eliminating marginal tax rates above 50 per cent, recognising and rewarding family formation, and delivering a lower overall tax burden. Now, that would be a manifesto worth voting for.
The post Iain Mansfield: How the Budget could be the springboard to a revolutionary manifesto on tax appeared first on Conservative Home.
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Author: Iain Mansfield
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