Tuesday, 29 June 2010

Fiscal drag is back

It has been a favourite weapon of governments over the years: fiscal drag. In other words, don't fully compensate taxpayers for inflation or earnings growth in terms of tax allowance. I don't blame the Coalition Government for using it, but quire a few people are going to be surprised to find that they are paying a marginal tax rate of 40 per cent.

Before Labour came into office in 1997 there were only 2.1m higher rate taxpayers in Britain. This rose to 3.87m just before the recession struck and has fallen back to 3.1m now.

Quite reasonably, the Government is seeking to make sure that increases in the starting tax rate intended to benefit the least well off do not also benefit the most prosperous. Quite how many people will fall in the higher rate tax band by the end of the Parliament is open to question:

1. Grant Thornton estimate the number will go up to 6.1m, i.e., almost double.
2. The Institute for Fiscal Studies estimates 5.7m by 2014-15: that's still nearly a doubling.
3. It is possible to interpret Government figures in a way that gives a figure of 6.25m.

Anway, it's clearly going to more or less double. Given that commuters into London are going to face (yet again) above inflation increases in rail fares, some voters in marginal seats in the south-east may not be happy bunnies.

James Brown at IFS argues that this increase is not contrary to past principles: that there is a very long basic rate tax band and only a few high earners should pay more.'

There is also now a higher band of 50 per cent which is not going to go any time soon so introducing, say, a 30 per cent band for the first 5k above the basic rate band would make the system even more complex when ideally one wants greater simplicity to reduce transactions costs for the tax authorities and taxpayers.

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