Patrick Nolan: The Coalition's policies on income tax thresholds and benefits for the elderly fail fairness tests

Patrick Nolan, Chief Economist, Reform.

Fairness is at the heart of this Parliament’s policy debate. In his speech to the Liberal Democrat Spring Conference yesterday Nick Clegg made no less than 23 references to fairness. The Labour Party leader, Ed Miliband, has spoken of a “fairness divide” between “the richest at the top who have been doing well” and the “majority – lower and middle-income.” The Spending Review was based on fairness, reform and growth. Yet, as a Reform report released today highlights, these claims of fairness are being used to justify major policy mistakes.

Policies such as punitive taxes on high income earners have the potential to make us all poorer. Both Nick Clegg (yesterday) and Ed Miliband have singled out the very rich in recent remarks. To illustrate the damage of this approach Reform modelled what would happen if a cap on income was introduced for very high income earners (on £1 million a year or more) so that income inequality (as measured by the Gini coefficient) would fall back to the levels of the 1980s. This showed that while inequality would fall, tax revenues (based on a static analysis) would also fall by £7 billion or by around 2p on the basic rate of tax. At a stroke tax burdens on low and middle income earners would rise and eliminating the deficit would become more difficult.

The report also highlights that the Coalition is wrong to propose increasing the personal tax allowance to £10,000. While the goal of reducing tax burdens is right, this is the wrong approach. Of the £14.2 billion reduction in tax from this policy, £13.2 billion would go to people with incomes above £10,000. The policy would encourage tax avoidance and reduce incentives to work for most earners. Reform has also released an online tax calculator (here) that allows people to see how a change in a personal tax allowance would affect them.

The report also shows that three-quarters of the £40 billion tax gap is due to VAT, Income Tax, National Insurance and Capital Gains Tax, i.e., the taxes paid by individuals and small companies. It is not right to say that reducing tax avoidance from large companies would mean public spending does not need to be cut. Reducing tax avoidance not only requires a focus on the big end of town but on the activities of small to medium enterprises and many families. The entire tax system needs to be simpler and less open to abuse.

While senior members of the Coalition have been right to argue that high government deficits impose burdens on future generations, intergenerational fairness requires reducing the costs of benefits to the elderly, through removing pensioner gimmicks such as free bus passes and TV licences and reversing the policy of linking the basic state pension to earnings. The reality is that many middle income families should also expect their living standards to fall over the next few years. These living standards were artificially inflated by high levels of debt and poor quality government spending, such as the wasteful middle class welfare money-go-round. This “borrow now, pay later” culture must end with a period of belt tightening.

Delivering fairness requires being honest about what the government can do and the living standards that people should expect. Fairness requires a real focus on prioritising spending and encouraging economic growth. It should not be used as a cover for narrow self interest or postponing hard decisions. Using claims of fairness to justify major policy mistakes is short sighted – this will hold back growth and make real fairness less, not more, likely.