Is Osborne really about to give people on £100k a tax cut?

This post originally appeared on Gavin’s New Statesman blog

As we close in on the budget most eyes are still fixed on the fate of the 50p tax rate. Ignore for a moment some of the squeals from Labour on this issue (more in excited anticipation that it will be axed than horror) and spare a thought for the dwindling band of true Tory modernisers. Their two central ambitions over recent years have been to demonstrate an unswerving commitment to the NHS, and to show that they could govern the economy — and tax policy in particular — in the interests of the broad majority rather than the affluent elite. They are struggling to believe that having watched the coalition conspicuously squander the first of these strategic objectives that it could be planning to deliver the last rites to the second too.

Yet whatever the decision on the 50p tax rate, the heated debate over it risks obscuring another more nuanced, but still highly revealing choice facing Osborne. Who should benefit from the widely expected and costly increase in personal tax allowances: the vast majority of all tax payers, including individuals to over £100,000 a year (and indeed households on £200,000), or just basic rate tax-payers? An important issue in its own right — and one which has been given new impetus by the coalition’s travails over Child Benefit.

To understand why this is the case, turn the clock back to 2010 when the personal allowance was first increased and the decision taken to limit the gains to basic rate tax payers. This was achieved by lowering the income threshold at which the 40p rate starts in order to cancel out the gains for higher rate tax payers — leaving them no better or worse off. Creating more 40p tax rate payers has obvious political downsides. However, it makes the personal allowances policy both less regressive and significantly less costly. The savings could be used to help reverse this year’s cuts to tax credits.

One of the key reasons why there was such a hostile reaction from many quarters to the initial decision to target the gains from the personal allowance in 2010 was the disastrous way it got caught up with Osborne’s proposal to abolish Child Benefit for households with a higher rate taxpayer. It meant those basic rate tax payers who found themselves shunted into the 40p rate not only faced a higher marginal tax rate but were also set to lose £1,750 of child benefit if they had two children. This was pure political poison. Consequently, when a further increase in the personal allowance was announced in 2011, a different approach was adopted and the gains went to higher rate tax payers too.

Which brings us to next week’s budget and how the decision that is set to be made on revising the policy on Child Benefit could also affect that on personal allowances.

To date, the coalition’s argument on Child Benefit has been that given the scale of the deficit it is no longer affordable to pay it to households with someone earning above £42,500; indeed it is also argued that it is morally unfair to ask low-income families to contribute towards higher earners’ Child Benefit. In which case you might well ask why we can afford tax cuts for individuals earning £100,000 (and households with a joint income over £200,000) regardless of whether they have children. You might also ask why it is fair to ask the same low-income family to contribute towards the cost of these tax cuts for the affluent.

I don’t know how the coalition propose to answer this. But as things stand they’ll need to do so next Wednesday. Pity the poor soul in the Treasury being tasked with drafting the “lines to take” for ministers.

There is, however, a potential get-out clause for them. The approach currently touted as the likely change to Osborne’s Child Benefit policy is to means-test the benefit at a higher level of income — say £50,000 rather than £42,500, meaning that roughly one million families would see their Child Benefit spared. Whatever other problems this creates (and there are plenty of them), this will make it possible to restrict gains from an increased personal allowance to basic rate tax payers without creating the toxic side-effect of stripping Child Benefit from those who get tipped into the 40p tax band. The coalition could, if it so wished, show that their priority really is basic rate tax-payers (and in doing so save money).

We’ll know soon enough. My tentative hunch is that they won’t opt to restrict the gains from increased allowances to 20p tax rate payers — even though it is clearly more progressive and cheaper. I doubt they’ll be willing to incur the price of creating more 40p tax-payers. If this is the case, the coalition will have some explaining to do, not least to their own backbench rebels on Child Benefit, on why a family on £50,000 should lose cash support while individuals without kids earning double that amount should get a tax cut.

And all this, of course, is before we get to the decision on whether to abolish the 50p tax rate…..