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KEY POINTS
- Leaks attempt to set the narrative in advance.
- Effect of personal allowance reductions is the same as setting 45% threshold at around £90,000.
- Was it really a VAT giveaway or an income tax giveaway?
Jeremy Paxman, it was said by a journalist on The Times, prepares for each interview with politicians by asking himself 'Why are these lying so-and-so's lying to me?'. (He used a slightly different name for them, but this is a professional magazine, not a Radio 2 show.)
I have a similar reaction to the synchronised flurry of well-informed leaks that always seem to hit the newspapers and airwaves just before the budget and pre-budget reports: 'How are these leaking so-and-so's lying to me?'
Because they are lying, although the lie is generally one of omission rather than commission. It's the misdirection of the conjurer, making you concentrate on the hand with the wand in it rather than the one that is surreptitiously loading the rabbit into the hat.
The question you always have to ask about budget leaks is what you would have thought if you had seen the details of the budget without having seen the leaks first.
There were two main leaks prior to this pre-budget report: that VAT was to fall temporarily to 15%, and that there was to be a new top rate of tax of 45% on those earning more than £150,000 a year from April 2011.
We were meant, therefore, to assume that the former was paid for by the latter — that everyone benefitted from the VAT reduction but that only the very rich had to pay for it. In fact, this narrative was wrong on one more obvious and one less obvious count.
Now you see it
The media are getting wise to the effect of the leaks these days, and most quickly realised that the sums did not add up in this way. The budget was billed as a £20 billion giveaway, and yet the amount clawed back by the 45% rate in 2011-12 is only £670 million.
Even when you realise that there is a reference missing in table B5, and that note 3 is meant to be cross-referenced to this line, saying that there will be a lag because of self-assessment and the full amount in subsequent years will be £1.6 billlion, this is clearly still not enough.
The net additional revenue to be raised in 2011-12 is £7.5 billion. The largest element of this is the effect of the National Insurance changes. The Chancellor announced that both the employer and employee rates of NI would be increase by 0.5%.
In total this raises some £5.15 billion. Offset against this is the cost of aligning the primary threshold with the personal allowance in the same year, £1.6 billion. Add on £250 million extra raised from the self-employed, and the net total is some £3.8 billion; so about half the net increase comes from the NI changes.
To be fair to the Chancellor these were changes which were clearly set out in the pre-budget speech itself, and also in the report. He is to be congratulated for being the first Chancellor in a quarter of a century who, when faced with the need to raise more money, increased the rate of income tax as part of his plan for doing so.
If he chose the less contentious route of raising National Insurance contributions for the greater part of the funding needed, perhaps he can at least be credited with doing so openly and not by stealth. In particular, he did so without adding significantly to the complexity of tax legislation; adding in a new rate of tax may make it slightly more complex to calculate, but in the days of computerised calculations this is hardly a problem.
Now you don't
Unfortunately the same cannot be said for the remaining way in which additional funds are to be raised from the tax system — a further £1.3 billion in a full tax year.
This is a complex proposal which, starting a year earlier in April 2010, creates two new thresholds at which the basic personal allowance will be withdrawn. Half will start to be taken away if gross income exceeds £100,000, and the other half if it exceeds £140,000.
Gross income for these purposes is total income less trading losses, but before personal allowances themselves. The allowances will be withdrawn at the rate of £1 for every £2 of excess income, and the notice even goes to the bother of explaining that, since the last digit of the basic personal allowance is always a five, if the full reduction applies then the remaining allowance will be rounded up to the nearest pound!
The net effect of this is to create two peculiar bands of high marginal rates. Despite the note about the personal allowance always ending in a five, assume for the sake of argument that the rate for 2010-11 turns out to be £6,500 (the low predicted inflation for 2010 should mean a low increase).
As shown in Example 1, a taxpayer who had no other deductions and no dividend income would face a marginal rate of tax of 60% on income between £93,500 and £1,000, then 40% up to £136,750, then 60% again up to £143,250, and then 40% thereafter. This will be confused still further in 2011-12, when in addition the marginal rate will become 45% for income over £150,000.
Where's the logic?
It is hard to see where the logic is in this approach. The old canard that the personal allowance is 'worth more' to higher rate taxpayers was trotted out yet again, but the pre-budget notice itself gives the lie to this, saying correctly that 'the basic personal allowance provides an amount of tax free income'.
It should not, therefore, be seen as an allowance which comes off the top of your income saving you tax at your marginal rate, but rather as your lowest slice of income which is tax free for everyone.
The mechanism for withdrawal will be familiar as the one used for withdrawing age allowance, and most readers will know the problems this can cause.
It is incompatible with the PAYE system, requiring estimates to be made of likely income and hence of the personal allowances which may ultimately be calculated. Inevitably these estimates will turn out to be wrong, meaning that people will either overpay or underpay, creating work for both HMRC and the taxpayers and their advisers. Isn't there a better way of achieving broadly the same aim?
Yes, of course there is — it can be done straightforwardly by reducing the point at which the new rate starts.
Taking the position from 2011-12 onwards to begin with, and ignoring the difference between gross and taxable income for the time being, Example 2 assumes the personal allowance is now £7,000.
The difference between the 40% and 45% rates is not that significant, so let's say that in total the extra tax to be taken by the time the £150,000 limit is reached should be £3,000.
Reducing the threshold at which the new 45% rate starts to £83,000 but allowing the personal allowances to be offset in full in the normal way should result in almost the same amount of tax being taken, and from not that different an income band, since the starting point for the withdrawal of personal allowances will be significantly below £100,000 once other deductions from total income such as personal allowances and pension contributions are taken into account.
However, this way would do it without a yo-yoing marginal rate of tax.
The difference, of course, is sleight of hand. The headline threshold for the change is £150,000, which only affects the top 1% or so of incomes. Drop that to £83,000 and you are reaching a level which rather more people reach and to which still more aspire. In short, you are beginning to reach the higher echelons of middle-England earners; Mondeo man in a very good year, and that means votes.
Better, therefore, to have a complex and unfair system of withdrawing personal allowances which no-one will understand. This is particularly true given that the promise not to increase the tax rate was given for a parliament, and it is not certain that the election will be held before April 2010, whereas no such guarantee was given in respect of withdrawing personal allowances.
The not so obvious
I said that the original narrative set by the leaks was wrong on a not so obvious count as well, and this is one which does not seem to have been picked up by the media. Regardless of what they said about how the giveaway was to be clawed back, they all seemed to concur that the giveaway itself had been the VAT reduction.
There is no doubt that this was the largest part of it, but if you turn to the figures it is not so clear that it was as overwhelming as the reports have suggested.
The VAT reduction is planned to last for thirteen months, from 1 December 2008 to 1 January 2010. It costs £3.8 billion in 2008-09 and £8.6 billion in 2009-10. That's a total of £12.4 billion. So where does the other £7.6 billion or so go?
The figures say, as they generally do, that they are calculated on an indexed base. However, the cost of indexing the basic rate of tax and the personal allowance is shown as just under £3 billion for 2009-10.
It is not immediately clear why this should be so, and I have not had time in the few hours between the speech and writing this article to confirm it, but I suspect part of the answer is that the indexation for these is done in arrears, reflecting the rates of inflation in the previous year.
With the rate forecast to drop significantly, and perhaps to fall below zero (in which case the rates and allowances would stay the same, they would not decrease), this could become quite significant.
There is more. The further increase of £130 in the personal allowance has to be taken into account, costing £630 million in 2009-10. Then there is the ongoing effect of the package to 'correct' the 10% debacle, costing a further £270 million in 2009-10.
Add these together, and nearly £4 billion of the giveaway in that year is actually going on reducing income tax.
There is no such ambiguity about 2008-09, is there? It all depends on your starting point. If you look purely at the pre-budget report changes and the £20 billion figure, then there is not. However, the table in the report gives the picture of changes since Budget 2008; in other words including the Chancellor's subsequent announcement of the increased personal allowance and reduced basic rate limit.
With hindsight, it is clear that one of the reasons he opted for giving money to everyone was that (as he made clear in his infamous Guardian interview) he could see the financial storms ahead, and that a fiscal stimulus was going to be necessary by the autumn. It would therefore make sense to add this in, and to refer to the combined package as a £24 billion pound giveaway, which is what Table B5 in the report does after adjusting for movements on reserves. On this basis, the total income tax giveaway is £2.7 billion in 2008-09 compared to the £3.8 billion in VAT.
The final way to look at it is to note that the indexation of personal allowance and the basic rate limit continues to cost money all the way through to 2011-12 (and beyond, but 2011-12 is as far as the report's calculations go).
For all years, in total this element of the package alone costs £9.5 billion. Add on all the other income tax reductions over the full four years and you get to £14 billion before accounting for the clawbacks in 2011-12.
So is this really an income tax giveaway rather than a VAT giveaway? Who knows. But I know what the Treasury wanted you to think.
