How helpful will a 1p tax cut be?

One of the measures that the Chancellor of the Exchequer announced in his financial statement on Friday was a 1p cut in the basic rate. This was already planned but has been brought forward a year.

I want to highlight some of the challenges around decisions concerning taxation when the aim is to help those who are just about managing and/or beginning to struggle.

The Chancellor had a few options here, assuming that he decided not to use the benefits system to put money back into people’s wallets. If you think that one of the best ways to help people is to cut the tax burden and you choose specifically to target income tax rather than sales taxes such as VAT then the options are.

1. Cut the basic income tax rate-the option favoured by former Conservative Chancellors such as Nigel Lawson and Geoffrey Howe.
2. Create lower rate tax bands. This method was used by Norman Lamont and Gordon Brown.
3. Increase the threshold at which people begin to pay tax. This was the method favoured by George Osborne, although I believe it to have primarily been an option adopted from the Liberal Democrats during the Coalition.

The Coalition Government substantially increased the threshold. This meant a lot of people saw their tax bills greatly reduced whilst some were taken out of the tax system altogether. There in lies it’s strengths and its weaknesses. It is a good way of targeting help to the least well off among the working population. From that point of view it helps people move from benefits to income as well. However, on the downside, there may be disbenefits to taking people out of the tax system altogether as it gives them less of a sense of having a stake in the services they receive from the Government.

If we come to the other two options then what is the impact? Well let’s look at what happens if we cut income tax by 1p in the pound as the Chancellor has announced.  Currently the threshold for paying income tax is 12,570.   The UK mean wage is about £31447. This means the average person pays tax on £18517 of their income.  The tax cut means they’ll get £185.17 back per year or £15.43 per month.  Of course if you are on a lower income say about £20,000 then you’ll be looking at £74.30 a year or £5 per month. In other words, not a lot at all.   However, someone earning £60k per year is looking at getting back £474 or  around about £40 per month which is starting to make a difference.

Now consider this.  If the Chancellor had reintroduced the old 10p tax band, say at £10,000 more than the initial threshold (£22,570), then anyone earning over that amount will be saving £1000 per year. Even if you are only on £20,000, you’re still saving about £370 per year. 

So, if you are looking to cut taxes in a way that delivers more money back to a wider amount of people and is more equitable, then I would argue that introducing a new lower rate would have been better.  Of course, a lower tax band, because it is giving more to everyone will cost the exchequer more.  However, the argument for lower taxes is that because that incentivises work and trade and because people hopefully put that money back into the economy, it should lead to longer term economic growth so that tax receipts go up rather than down.