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Tough Times, Fairer Taxes?

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The tag line of this year's Liberal Democrat Party conference was 'fairer tax in tough times'. Perhaps too much should not be read into such slogans, yet it does reveal the two key messages the party wishes to project at the mid-term of this parliament. The first - 'fairer tax' - is part of its differentiation strategy to emphasise the party's distinct successes in Coalition; more specifically raising the personal income tax threshold to £10,000 per annum by 2015. It also underscores the Party's commitment to using the tax system and other levers to promote social justice, of which the proposed 'mansion tax' is another example.

The second element - 'tough times' - emphasises both the size of the challenge in repairing Britain's economy and the Liberal Democrats commitment to taking the difficult decisions that this entails. As Nick Clegg and others discussed in their speeches to the conference, the party remains committed to the difficult deficit reduction programme that was embarked upon in 2010 when they formed the Coalition.

The two messages are related; they seek to demonstrate the maturity of the party in taking difficult decisions on public spending while promoting fairness and protecting the most vulnerable in society. Much of this messaging was focussed on the commitment to raising personal income tax allowances; numerous senior Lib Dems referred to the pledge in their speeches and during fringe events. Danny Alexander also signalled that the party was committed to lifting all of those on the minimum wage out of tax altogether in the next parliament.

The commitment to this policy is easy to understand; raising income tax allowances puts money directly into the pockets of those on the lowest incomes. It is distinctly Lib Dem and seemingly progressive in that it requires little or no contribution from those least able to make one. Placing this at the centre of their next manifesto provides a framework around which the party can develop a distinct narrative on its achievements in Government and its future objectives of promoting fairness.

However this policy is not as progressive as it at first appears. In simple terms, the poorest are lifted out of tax; yet it is based on personal, not household income tax. As a result, cohabiting or married couples benefit twice from the policy, unlike single income and single parent households. The Institute of Fiscal Studies and Resolution Foundation have undertaken research into the drawbacks of raising tax allowances and expressed doubt over its benefits, concluding that it may actually be a regressive policy with regards to the lowest earners.

Another criticism is that it is not as radical as it may at first appear; inflation alone would have pushed personal income tax allowances up to around £8,500. As such, it will only deliver a real term tax relief on £1,500 of income, or £300 a year in each individual's pocket (this is without adjusting for tax credit or National Insurance changes). The Resolution Foundation forecast that the benefit of tax changes in the 2012 budget, where the threshold was increased to £8,105, equated to £41 per year for basic rate taxpayers. Although not to be scorned it is not a substantial or fundamental change in income, even for the lowest paid.

This failure to link the policy to inflation means that it is unable to take account of increases in living costs, diminishing its overall effectiveness. The additional £300 will likely be wiped out by the above inflation rises in living costs brought about by particularly high food, energy, and oil costs that are predicted to continue in the coming years. In addition, rail fares, housing and childcare costs, - are amongst the highest in the European Union - remain a heavy burden on families.

The policy is further undermined by being linked in the long-term to the National Minimum Wage (NMW). Lifting all of those on the NMW out of tax is an admirable ambition, but only if it keeps pace with the cost of living. Although a very important mechanism for protecting the low paid the NMW is essentially arbitrary; unlike the Living Wage it is not predicated on a detailed assessment of living costs. Consequently it does not reflect the challenge posed by increases in living costs nor keep pace with inflation. In October 2011 the minimum wage increased by approximately 2.5% and will increase by just over 2% this year; this is despite inflation peaking at 5.2% last September.

No policy is perfect nor can it ever deliver only the desired outcomes; unintended consequences are a fact of political life. However the several drawbacks of raising personal income tax allowances raises the question of whether it is the right policy to frame the fairness of the Liberal Democrats, their successes in Government and their future objectives. It is likely that a much wider narrative - including tackling living costs and promoting fairer wages - will be required if the party is to achieve its ambition of delivering fairer taxes in these ever tougher times.