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Tuesday, July 23, 2013

The case for taking the tax threshold up to the minimum wage

I am not normally in the habit of quoting from the Adam Smith Institute website but their letter to the Archbishop of York in response to his call for a Living Wage is well-worth reading if only for learning how a small tweak in the tax system could leave somebody on the minimum wage better off than their equivalent on the higher rate.

There has been a sustained campaign by Liberal Democrats in government to take the low-paid out of tax. The tax threshold will rise to £10,000 from 1 April 2014 meaning that since 2010, the Liberal Democrats will have taken 130,000 low-paid people in Wales out of tax altogether and cut the tax bill for 1.1 million more this side of Offa's Dyke. Under Labour the tax bill for somebody on the minimum wage amounted to £1,018 in 2010. Under the Coalition Government it is now £573.

However, we want to go further and raise the tax threshold to the level of the Minimume Wage. This is also an objective endorsed by the Adam Smith Institute and their figures illustrate how this will benefit many people:

if it were not for the amount that government takes from such meagre wages then the minimum wage would indeed be, to an acceptable level of accuracy, that living wage.

An example to make this clear. Assume 37.5 hours a week of work for 52 weeks of the year. At that living wage of £7.45 an hour this is a gross weekly income of £279.40 (I round slightly) or £14,527.50 a year. We are all agreed that this is not a large sum.

From this sum the recipient will have to pay employees' national insurance. This starts at £109 per week and is charged at 12%. £20.50 per week in such charges, or £1,063.30 per year.

There is also income tax to pay. This starts at £9,440 this year and is charged at 20%. £1,017.5 in such taxation.

We can see therefore that the net income from the living wage is some £12,446.70 a year. This is not greatly different from the gross income on the minimum wage: £6.19 an hour for 37.5 hours for 52 weeks is £12,070.50. Or if we wish to bring that back to a rate per hour, the difference between the post-tax living wage and the pre-tax minimum wage is some 19 pence per hour.

Unfortunately it does not stop there. There is also employers' national insurance to pay. Some insist that it is actually the employer who carries the burden of this tax. Almost all economists disagree, insisting that it is the employee who does in the form of lower wages. Indeed, we have it on the word of an expert of great eminence, Richard Murphy of Tax Research (who is funded in part of the Joseph Rowntree organisations, just to show his impartiality on this point), that it is indeed the employees who carry the burden of this tax. The calculation is slightly complex, but it's reasonable enough to claim that it is a further 13.8 % of those wages (it isn't, it's 13.8% of the total wages including the employers' NI but let us keep the maths simple) meaning a further £20 to £23 a week deducted from those wages. Or a further £1,196 a year.

If we add all of this together we find that the living wage of £7.45 an hour actually provides a lower post-tax standard of living than the minimum wage of £6.19 an hour free of taxation would provide.

That latter would provide £12,070.50 a year to live on. By no means a great sum but still larger than the £11,250.7 that is available from the living wage after the politicians have taken their very much more than tithe.

It is indeed possible to play with these calculations, to make them more accurate. But the same end result will always come out. The current minimum wage, free of income tax and national insurance, would provide a higher standard of living than the proposed living wage under the current taxation system.

It is for this reason that I have been proposing for some years now, in fact ever since the first JRF calculations on the living wage were published, that the personal allowance for both income tax and national insurance be raised to the full time full year minimum wage. This would, at a stroke, raise that minimum wage to a higher standard of living than the proposed living wage. With the advantage that we only have to convince the Chancellor of the Exchequer of the righteousness of this path, not millions of employers across the country.

The Living Wage is a worthwhile goal but from the point of view of government the most effective and immediate way to help the low paid is to take those on the minimum wage out of tax altogether. That should be a key pledge for the next government, building on what the Liberal Democrats have already achieved.
No, the most effective and immediate way to help the low paid is not to tinker around with thresholds but to reduce VAT to 15%. Stimulate the economy at the same time, what's not to like?
I disagree. Most of those on the lowest incomes will spend a hig proportion of their money on non-VATable goods such as food. The best way to help is to maximise their income and let them choose how to spend it. Also a large number of VATable goods are imported so you will not even be stimulating demand in the UK.
No offense Gav, but that is a ridiculous thing to say.

Raising the tax threshold to £10k is not "tinkering around" at all. And raising it to the minimum wage wouldn't be tinkering at all. It would be an incredible thing to do.

Messing around with VAT, on the other hand, is major 'tinkering' IMO! I suppose it might stimulate the economy (although when Brown lessened it, it didn't make a blind bit of difference), but the tax threshold makes for more of a difference to the lowest paid (and encourages work, which also stimulates the economy.)
Apologies for not getting back earlier. Apologies too to Anonymous if I may have hit a nerve.

It's self evident, I hope, that tinkering with the income tax threshold will have no effect at all, let alone benefit, on people whose income is less than this. On the other hand as these people are apparently paying around 10% of their income on VAT (there's some ONS data on this if you're interested) it's similarly self evident that they will benefit from any reduction in VAT however small.

I'm away again from tomorrow, for a couple of weeks, but if you're at all interested in a serious discussion on this I'll get back to you then with some illustrative figures.
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