So, the Conservatives plan to raise the threshold for both employers’ and employees’ NICs (£24 and £21 per week, respectively), paid for partly by a rise in the Upper Earnings Limit and partly by £6bn in net spending cuts (these cuts commencing in 2010/11).
Policy Exchange has previously argued that it should be feasible to achieve some £5bn-£10bn spending cuts in 2010/11, and that this would be more likely to promote recovery than to impede it and to limit the rise in unemployment than to drive it. We thus obviously welcome this announcement as a first step.
Furthermore, Policy Exchange has argued that the rises in employers’ NICs were likely to be particularly damaging to jobs and growth in the short- to medium-term. Employers’ NICs rises will, like rises in Employee NICs, eventually convert into reductions in real post-tax salaries. But whereas employee NICs rises achieve this directly, rises in employers’ NICs first raise the costs to employers of hiring staff, which means fewer staff are hired, unemployment rises, and eventually salaries are bid down. So the route to equilibrium proceeds via increased unemployment in the short term. This process of returning to equilibrium might involve particularly significant increases in unemployment for a material length of time in an environment of low inflation and widespread salary cuts — as at present.
By raising the thresholds, the Conservatives would reduce the impact on jobs — particularly the impact on the jobs of the low paid. Of course, there would still be an impact on the jobs of the better off, but few choices are appetising when the deficit is nearly 12% of GDP.
It is interesting to note the decision to proceed via a rise in thresholds rather than a reduction in rates. This represents a marked shift of approach from the Brown years (and indeed the Major years) when the mechanism chosen to reduce taxes for the lowest paid was to introduce lower rates (such as the 10p band). The Brown/Major approach was, of course, more cosmetic than substantial in its impact on the lower-paid, for those at the bottom clearly benefit more from paying no tax (when thresholds are raised) than by paying tax at a lower marginal rate.
In our recent report, we analysed the relative impacts on growth of raising income tax thresholds versus changes in the basic rate of income tax. Those lessons are also broadly applicable to a rise in NI thresholds versus a cut in the NI rate. We found that the overall growth impact of raising thresholds was likely to be fairly similar to that of cutting rates (in the case of NICs, both would be good for growth), but that the distribution was likely to be rather different, with the lower paid potentially gaining more from threshold rises. The exact details would, however, depend very much upon the interaction with the benefits system — in particular, growth would be promoted most if certain of our proposed reforms to the benefits system were implemented.
We will watch with interest to see whether the tax cuts on this occasion — a rise in thresholds, rather than a cut in rates — constitute an indicator of the direction for future tax cuts. Perhaps a significant rise in income tax thresholds at some point (once the deficit has been addressed satisfactorily) might yet be on the cards?
Andrew Lilico is Policy Exchange's Chief Economist.