Osborne the reformer is an unfinished work

Published on Public Finances and the Economy

One interesting aspect of today’s Budget is the government’s change of tack on personal allowances. Back in June 2010, when the Chancellor committed to raise allowances from £6,475 to £7,475, he chose to cancel out the gains for higher rate taxpayers by lowering the level at which the 40p tax rate kicks in. The idea was to focus the gains of the policy on basic rate taxpayers, making things a little more efficient. The 40p threshold will therefore be lowered from April this year from £43,875 to £42,475 with the result that 700,000 people will become higher rate taxpayers.

Needless to say, that’s proved unpopular, and so this time around the higher rate threshold won’t be reduced. When personal allowances go up by £630 to £8,105 in April 2012, as announced today, the higher rate threshold will stay flat in cash terms at £43,875. Because that freeze had already been announced in Labour’s March 2010 Budget, Osborne can say that today’s Budget both lowers the personal allowance and creates no new higher rate taxpayers. That’s a dual commitment that Tory and Lib Dem strategists are clearly coming to see as important in squaring the circle on their tax-reform plans.

Put this all together, though, and there are significant implications for the distributional effects of the personal allowance policy. The good news is that families with children who earn around the higher rate threshold may do better than previously thought. They’d previously not looked likely to benefit from the allowance policy – or even to potentially lose out, as they were shunted into higher rate tax and made ineligible for Child Benefit from January 2013. Now, it looks more likely that, as things move forwards, these kinds of families will see small gains.

But the more dramatic result of not ‘netting off’ gains for higher rate taxpayers is that personal allowances become an even less efficient way to raise living standards for low-to-middle earners. The £48 tax-cut represented by today’s allowance move will go to all individual taxpayers on incomes up to £100,000. That means some households on incomes of £200,000 will gain around £100 a year.

It’s very hard to square that with the government’s claim that deep cuts to tax credits for low-to-middle income working families are absolutely necessary. In particular, it’s hard to understand why money is being taken out of childcare support for working parents – which not only raises incomes, but also enables low-to-middle income mothers to raise their own living standards by staying in work.

For Nick Clegg, ultimately it will be pleasing to see his tax agenda dominating debate. But he also faces growing risks. More people are coming to realise that his flagship tax-policy, billed as a tax-cutting measure for low income people, is focused increasingly on higher income households.

And for Osborne too there are challenges. His eyes are on a legacy as a reformer, not just an axe-man. To gain credit, he – and like-minded Lib Dems like David Laws – needs to leave Britain with a simpler, lower, more efficient tax system fit for low-to-middle income Britain, the people at the sharp end of today’s squeeze of wages and inflation.Today’s Budget didn’t do much to reassure on that front.