This is an article for the Institute of Welsh Affairs
Despite claims to the contrary by the opposition, the UK Coalition’s tax policy has been a major success.
Thanks to the contribution of the Liberal Democrats 175,000 low paid workers in Wales no longer pay income tax, whilst from April 2015 a further 1.1 million workers will be £820 a year better off since 2010 as a result of the increase in the personal allowance to £10,600 a year.
Under the previous Labour Government those on the minimum wage were paying over £1,000 in tax. Under the current administration that has more than halved.
But this is not the only area where changes to tax policy have led to a fairer regime. It is a fact that despite the cut in the upper rate of tax, over the five year term of the current government a millionaire will have paid £381,000 more in tax than he or she would have done between 2005 and 2010.
Total income tax collected from people earning more than £150,000 has surged from £40bn to £49bn in 2013-14 compared to the year before (1). This is higher than at any point under the last government, and twice as high as under the Callaghan government (when the top rate of tax was 98 per cent).
That has more than made up for the loss of tax revenue from lower earners following the big increase in tax thresholds.
The top 1% of earners now earn 13% of the income but pay 28% of the total income tax. The top 5% earn one quarter of the income but pay around half the total income tax.
In addition, measures to tackle tax avoidance will bring in an extra £7.6 billion for the UK Treasury in 2015-16.
Raising personal allowances as a means to help the low-paid is far more effective than fiddling with lower tax rates as it deals with qualifying thresholds rather than marginal gains.
Thus, whilst a 10p tax rate may significantly reduce the tax liability of somebody on the minimum wage, raising the tax threshold to £13,520, which is the ultimate aim of Liberal Democrats policy would mean that that worker would pay no income tax at all, and would take home not far short of the post-tax living wage as it currently stands.
The Institute for Fiscal Studies in February 2013 (2) said that reintroducing Labour’s 10p rate in full would reduce tax revenues by around £7 billion a year and benefit basic rate taxpayers by up to £271 a year. They say that it is unlikely that anything close to this amount could be raised through a mansion tax alone and that this will leave a black hole in Labour's plans.
Secondly, they said: A far simpler and more sensible way of achieving these aims would be to spend the same amount of money on increasing the personal allowance – a policy on which the current government has already spent £9 billion a year. This would have virtually the same impact on individuals’ tax payments, be slightly more progressive, take some people out of income tax altogether and avoid the complexity involved in introducing a new income tax rate.
Although the Liberal Democrats support the Living Wage, I think that we can see that applying it universally is problematic. In-work poverty is a massive issue, and the fall in tax yields underlines how, despite unemployment falling, many people are taking on low paid or part time work and are still struggling to make ends meet.
It is feasible for public sector employers to ensure that nobody who works for them receives less than the living wage. Indeed, the Welsh Assembly Commission has done that, and gone further by insisting that their contractors also pay the living wage to employees working in the Assembly.
That though is costly, and in times of austerity and cuts, difficult to insist on, though some councils have done it.
Unless the living wage also becomes the statutory minimum, we cannot force private employers to follow suit. Raising the personal allowance can ensure that low-paid workers in both the public and private sector benefit with the UK Treasury bearing the cost.
There remains one issue which needs to be resolved and that is national insurance payments. Workers start to pay national insurance once they earn more than £8,000. It is charged at 12 per cent for most workers.
The Liberal Democrats draft manifesto says that we will consider “raising the employee national insurance threshold to the income tax threshold, as resources allow”. The Institute of Fiscal Studies say that aligning the income tax allowance and national insurance thresholds would cut taxes for 1.2 million workers.
That is the best way to alleviate in-work poverty.
(1) HM Revenue and Customs - Tax Liabilities Feb 2014 edition