House of Commons - Treasury - Thirteenth Report

Select Committee on Treasury Thirteenth Report

4 Options and decisions relating to the current tax year

69. In view of the public impact of the implementation of the new direct personal taxation system for the current tax year, it became evident by the time we announced our inquiry that the Government would need to consider actions relating to the current tax year as well as future years. The Government's intention to act in relation to the current tax year was confirmed in the Chancellor of the Exchequer's letter of the following day.[184] In this chapter we survey the options that were available to the Chancellor of the Exchequer in relation to the current tax year and then explore in more detail the option that was eventually chosen and announced on 13 May.

Payments to pensioners and others

70. As we noted in the previous chapter, a substantial category of losers is composed of people between the ages of 60 and 64 with a low and generally fixed income, largely composed of women in receipt of the Basic State Pension.[185] In his letter to the Chairman of this Committee of 23 April, the Chancellor of the Exchequer outlined approaches that could be taken which would be targeted on this group:

For pensioners aged 60-64, whose incomes tend to be more stable [than those of low-paid workers without children], we have put in hand work to see if those household who have lost out from the removal of the 10p starting rate of income tax can be helped through the mechanism that already exists to pay the Winter Fuel Allowance.[186]

71. The current Winter Fuel Allowance is paid to all households with someone over 60. It is thus not means-tested and not specific to those aged between 60 and 64. Some submissions questioned whether a comparable payment mechanism could be used to target only those aged 60 to 64.[187] The LITRG suggested that such a payment could only be targeted on this group by offsetting the gain to those aged 65 and over with a reduction in the age-related income tax allowance.[188] Age Concern argued that the mechanism used for the Winter Fuel Allowance would be the wrong mechanism to compensate people for tax changes because it would not be a means-tested payment.[189]

Options relating to Working Tax Credits

72. The Chancellor of the Exchequer in his letter of 23 April to the Chairman of this Committee stated:

For other low paid families currently outside the Working Tax Credit system, while we will examine in our review all practical propositions, our focus is on potential changes to the tax credits system to allow the average losses from the removal of the 10p starting rate of income tax to be offset.[190]

Later that day the Prime Minister indicated that measures relating to Working Tax Credit considered for the Pre-Budget Report would relate "to young people and part-time workers".[191] Options that could have been considered in this context included increasing the Working Tax Credit for single people without dependent children, reducing the Working Tax Credit hours rule for single people without dependent children to 16 hours, extending Working Tax Credit to those aged 16 to 24 without dependent children and a reduction in the Working Tax Credit withdrawal rate.[192]

73. The NPI stressed that any remedy to compensate losers needed to be understandable to the general public, be seen to be fair and not require people to claim back what was taken from them automatically. They opposed compensating tax losers through the tax credit system, arguing that it would not effectively target individual tax losers. They pointed out that compensating people via the tax credit system would mean saying that "you are going to compensate this low earner because they belong to a low income household but not this otherwise identical one whose household income is a bit higher". The NPI also pointed out that "the link between low paid workers and low income households is weak, with only 16% of low paid workers in a recent study belonging to households below the official poverty line". For these reasons the NPI believed that compensation delivered through the tax credit system would fail the 'fairness' test.[193]

74. Other organisations also argued against compensating people via the tax credits system. Mr Whiting told us that "the chosen route does have the advantage of being simple to administer" whereas "tax credits are themselves complex and would not hit a number of categories of people" who would continue to miss out.[194] Mr Ian Mulheirn, Chief Economist at the SMF, concurred, telling us that it was an inefficient way of targeting people who lost out as a result of the abolition of the starting rate of income tax and that it would have led to over-compensating certain groups whilst other groups of losers would not benefit from the change.[195]

75. The IPPR and SMF also highlighted the fact that many of the proposals to reform tax credits would be difficult to implement by April 2009. The IPPR, whilst arguing that there was a strong case in principle for extending eligibility to Working Tax Credit to those under 25 without children, said that "changes to the tax credit system take time to implement and it is hard to see how anyone would have received extra money until April 2009 at the earliest".[196] The SMF agreed and told us that "the tax credits system is complicated and fragile, making substantial changes difficult in short time-frames".[197] In particular, the SMF stressed that reducing the Working Tax Credit hours rule for single people without dependent children to 16 hours and extending Working Tax Credit to single people aged 16 to 24 without dependent children could be difficult to implement by April 2009.[198] The Chancellor of the Exchequer acknowledged the practical difficulties of making substantial changes to the tax credit system in a short period of time when he told the House in his 13 May statement on income tax that after examining possible changes to the tax credit system, he had concluded that "changes to the eligibility for tax credits could not be introduced this year".[199] Mr Whiting noted that the use of tax credits as the vehicle for compensation was further weakened by problems around take-up.[200]

Options relating to National Minimum Wage

76. The Chancellor of the Exchequer in his letter of 23 April stated that "the Secretary of State for Business, Enterprise and Regulatory Reform and I have asked the Low Pay Commission to report on what changes could be made to the minimum wage regime to support younger workers".[201] The Low Pay Commission was established as a result of the 1998 National Minimum Wage Act to advise the Government about the National Minimum Wage. There are currently three bands for the National Minimum Wage:

An adult rate for workers over the age of 22, which will rise to £5.73 per hour from October 2008;
A development rate for workers aged between 18 and 21, which will rise to £4.77 per hour from October 2008; and
A youth rate for 16 and 17 year olds, which will rise to £3.53 per hour in October 2008.

77. While there was some support in evidence for the Government and the Low Pay Commission to examine possible changes to the minimum wage regime to increase support for younger workers, there was also consensus that, in the words of the TUC, "the case for these reforms stood on their own merits, rather than as a mechanism for delivering recompense for the abolition of the 10p band".[202] The LITRG also argued that changes to the National Minimum Wage were not a cost-efficient or well-targeted way to deliver compensation.[203] The timetable for implementation of changes to the National Minimum Wage also makes it hard to envisage any such changes being relevant to compensation arrangements for tax changes in 2008-09.[204]

Options through the tax system

OVERVIEW

78. The problems identified with each of the three main potential mechanisms referred to in the Chancellor of the Exchequer's letter of 23 April led to the conclusion in the overwhelming majority of the evidence submitted that the Government was right to seek a solution to the problems created by the removal of the starting rate of income tax through the tax system itself.[205] As the LITRG put it:

The tax system provides mechanisms that enable the right people to be compensated, whereas directing compensation through tax credits, welfare benefits or the National Minimum Wage would have risked helping some who did not lose out and missing others who did … Income tax is pretty well universal, while tax credits and benefits are targeted on individuals in specific circumstances. Hence one cannot hope by the use of tax credits or benefits to compensate all losers from this tax measure. This is why we believe that the tax system is the most accurate and reliable vehicle for ensuring full compensation reaches everyone affected.[206]

79. Within this broad consensus, there were, however, a number of different possible approaches through the tax system which are worth examining briefly before turning to the detailed examination of the actual path chosen on 13 May.

REINSTATING THE 10 PENCE RATE OF INCOME TAX

80. In view of the fact that the removal of the 10 pence rate of income tax in one fell swoop was the origin of the Government's difficulties with personal taxation in 2008-09, it is striking that we received little evidence advocating the reinstatement of the starting tax rate. The Exchequer revenue foregone from reinstating the starting rate without other changes would be £7.3 billion in 2008-09.[207] The TUC pointed out that 92% of the benefit of restoration would go to individuals who had not lost from the removal of the starting rate.[208] The Association of Chartered Certified Accountants was alone in arguing that the Government should "seriously consider" reversing both the substantial personal tax changes in the 2007 Budget, in other words, restoring both the starting rate and the previous basic rate of 22 pence.[209] The LITRG referred to the possibility of, but did not advocate, reinstating the starting rate, but then clawing it back as income rose, so that income could be clawed back at a rate of £1 for every £4 of income above the starting rate limit; this would mean that there would be full recovery only when income reached about £18,000. The LITRG admitted that this solution would bring greater complexity into the tax system and add to the problem of high marginal deduction rates for those on relatively low incomes.[210]

A TAX REBATE OR SUBSTITUTION PROGRAMME

81. The LITRG offered two suggestions designed specifically to target those who lost from the removal of the 10 pence tax rate. The first would be to offer a rebate to those who could demonstrate that they lost out as a result of the income tax changes in 2008-09 compared with the tax they would have paid under the personal tax system operating in 2007-08.[211] The second and preferred solution would be to reintroduce the starting rate for 2008-09, but apply it only to those with incomes of less than £16,500.[212] The advantage of both these suggestions is their capacity to target losers from the removal of the starting rate very directly, minimising "deadweight costs", so that the total cost would be in the region of £1 billion. The disadvantages are that they greatly add to the complexity of the tax system and that the gains would not be deliverable until after the end of the current tax year.[213] In his statement on 13 May, the Chancellor of the Exchequer said he had considered a rebate scheme but had concluded that it would be "complex and expensive to administer".[214]

CHANGES TO ALLOWANCES

82. Beyond reinstating the 10 pence tax rate in some form, the main options for compensation in 2008-09 involve changes to allowances. Age Concern pointed out that the problems affecting pensioners aged between 60 to 64 could be eliminated or reduced by further age-related allowances, either by extending eligibility to the current higher allowance for those aged 65 and over to those aged 60 to 64, or by introducing an allowance for people aged 60 to 64 equating to the level of the standard Pension Credit guarantee rate for a single person, which would be £6,450 in 2008-09.[215] We return later to the possible use of further age-related personal allowances in future years.[216]

83. The SMF made the case for tapered personal allowances, so that the personal allowances for low-income individuals would be increased by £1,135 and tapered to the current personal allowance for incomes above £19,000. This measure would be very well-targeted on those losers from the removal of the starting rate, but would effectively create a different basic rate of income tax for those with earnings between the higher allowance and top of the taper. It would compensate almost all the losers from the removal of the starting rate, at a cost of around £1.5 billion.[217] The Chancellor of the Exchequer indicated that he considered tapered personal allowances prior to his 13 May decision.[218] We return later to the possible use of tapered personal allowances in future years.[219]

84. The simplest change that can be made is an increase in the personal allowance for all those paying income tax. The NPI, in a submission that reached us prior to the Chancellor of the Exchequer's own announcement on 13 May, argued that the problem with such a change was that it would benefit higher rate taxpayers. Instead, they argued for an increase in the personal allowance accompanied by a reduction in the amount of taxable income subject to basic rate tax. This was the measure the NPI recommended.[220] The NPI's proposal was similar to the option chosen on 13 May, to the detail of which we now turn.

The decision announced on 13 May

OVERVIEW

85. The 13 May announcement was of a movement in two thresholds. First, there was an increase in the personal allowance (that sum of money which can be earned before any tax is paid) by £600 to £6,035.[221] Second, in order to stop those on higher incomes benefiting from the change, the threshold after which higher rate tax (at 40%) is paid was lowered by £1,200.[222] By changing the tax bands for the entire tax year, the move was retrospective, although the benefits will not be felt before September 2008.[223] In his statement to the House, the Chancellor of the Exchequer said that the increase in the personal allowance would mean "that 22 million people on low and middle incomes will gain an additional £120 this year" and that "4.2 million households will receive as much, or more than, they originally lost".[224] While this means that most basic rate taxpayers will gain by £120 a year for this financial year, the IFS noted that those now within the range of income newly covered by the increase in the higher-rate tax band would lose some proportion of the £120. The IFS set out who would gain as follows:

The £600 rise in the [Personal Allowance] from £5,435 to £6,035 and the corresponding change in the higher-rate threshold give £120 to almost all basic-rate taxpayers (individuals with incomes between £6,635 and £40,835), and give between £0 and £120 to those with incomes between £5,435 and £6,035 or between £40,835 and £41,435.[225]

In his statement, the Chancellor of the Exchequer outlined his reasoning for such a generous package:

My proposal will also provide additional support for individuals and families this year, including those on middle incomes who have benefited from other reforms announced in 2007. We are providing that support at a time when they are facing additional costs. I have brought forward this measure from the Pre-Budget Report in order to ensure that people get the benefit as soon as possible.[226]

We consider later in this Report the fiscal implications of the 13 May announcement.[227]

IMPLEMENTATION

86. As we have already noted, implementation of this measure will not be until September 2008, although it will then have backdated effect to the start of the tax year. The LITRG welcomed "the speed of its implementation",[228] and the SMF welcomed as its key virtue its "simplicity from an operational perspective" which allowed the Chancellor of the Exchequer to "backdate the change to April this year".[229] The simplicity of the change was picked up on by Mr Whiting, who told us that:

When all is said and done, it is quite a simple change because of the nature of the PAYE system. Because of the data already stored they can very quickly send out instructions to employers. We have got until September to just adjust PAYE codes … what is being chosen is an administratively simple route that can just be done, that people can follow, it has a lot of attractions; the downside is … it is an expensive route and has various other implications.[230]

We asked the Treasury why it was taking until September to implement the changes. Its response was as follows:

The Chancellor of the Exchequer said in his letter to the Treasury Select Committee on 23 April that he did not wish to wait unnecessarily until November to compensate people for the average loss households have incurred. The measures announced on 13 May were brought forward from the Pre-Budget Report because of the time needed to implement this change and so that people could benefit from the increased income tax personal allowance as soon as possible. The changes will be effective from Royal Assent, although the effects on pay packets will not be felt until September.[231]

Although most welcomed the announcement of 13 May, some expressed reservations. The ICAEW noted that, while the change was simple for HMRC:

The burden of implementing this proposed change mid-year for employees will fall on employers. We are concerned that the cost implications of this should be investigated fully before the change is implemented.[232]

The Treasury downplayed the cost to employers, and insisted that support would be available to employers, informing us that:

HMRC and employers' representatives have long established processes in place to ensure any changes to tax can be implemented by businesses as soon and simply as possible. As part of this, HMRC is talking to employers' representatives about the smooth and timely implementation of the changes announced by the Chancellor of the Exchequer. Each year, HMRC sends a CD-ROM to employers so that they can automatically implement the annual Budget changes. HMRC will follow this well-understood process in implementing the changes announced by the Chancellor of the Exchequer. HMRC will issue an updated CD-ROM to employers, which will include all the details to enable an employer to automatically implement the changes. For smaller employers who continue to operate their payrolls manually, HMRC will provide tax tables to help them deal with the changes.[233]

THOSE WHO STILL LOSE

87. In his statement the Chancellor of the Exchequer referred to those who still lost in his statement:

The remaining 1.1 million households will see their loss at least halved. In other words, 80%. of households are fully compensated, with the remaining 20%. compensated by at least half. In addition, 600,000 people on low incomes will be taken out of income tax altogether.[234]

The IFS provided the following analysis as to the number of people (rather than households) who would lose, and what their incomes might be:

People aged under 65 with non-savings income between £6,635 and £13,355 are still paying more in income tax than they would have been had none of the changes mentioned above taken place. We estimate there to be around 6m people in this category (although only 2.9m are paying more than £1 a week extra in income tax). The loss is greatest, at £112 a year (equal to the original loss of £232 less the £120 cut in income tax from the rise in the personal allowance), for someone earning £7,755.[235]

The LITRG provided the information contained in Table 2 to illustrate the impact of the changes announced on 13 May on those with particular incomes:

Table 2: Effects of changes in personal taxation from 2007-08 to 2008-09, including changes of 13 May 2008, for selected low incomes

Annual income £	Tax in 2007-08 £	Tax in 2008-09 £	Annual Gain/(loss) £
7,000	177.50	193	(15.50)
8,000	342.90	393	(50.10)
9,000	562.90	593	(30.10)
10,000	782.90	793	(10.10)
11,000	1,002.90	993	9.90

Source: Ev 80

The IFS pointed out that "many of the individuals still paying more income tax may live in families or households with someone who is paying less income tax such that the family (or household) overall does not lose".[236] As such, the IFS calculated that "After consideration of all the additional measures announced for 2008-09, we now estimate that 0.9 million families are still worse off by more than £1 a week from the measures announced in Budget 2007, PBR 2007, Budget 2008 and Finance Bill 2008".[237] The IFS also calculated that "If no-one without children claimed Working Tax Credit, we estimate there would be 1.2 million families losing".[238] The difference between the IFS estimate of 0.9 million losing families and Treasury's estimate of 1.1 million losing families was, according to the IFS, due to the fact the Treasury used the household unit of measurement, and counted all losses in weekly income above 5 pence rather than £1.[239]

88. These different methods for calculating the losers affects the information the Treasury and IFS provided on the losing families or households. The IFS described the losing families as follows:

Of the 0.9 million families who still lose, 500,000 are single adults without children under 25, 115,000 are single adults aged 25 to 55 without children, and 140,000 are couples both aged 25 to 55 without children. Few are families with children (15,000 losers) or pensioner families (20,000 losers).[240]

The IFS then went on to note what would have happened if they had used a household unit of measurement, stating that:

It should be noted that this analysis would have been considerably different had we examined winners and losers at the household level: although 500,000 single adults without children under 25 have lost by at least £1 a week, almost all of these live in a household with other adults.[241]

This difference became apparent from the Treasury's description of the remaining 1.1 million households that still lose. The Treasury provided the age of the Household Reference Person for the remaining losing households. A Household Reference Person is defined as follows by the Treasury:

[The] Household Reference Person is the person who owns the home, or is legally responsible for the rent. Where there are more then one that fit this criteria, the [Household Reference Person] is the person with the highest income.[242]

Table 3 shows that most of the losing households have a Household Reference Person in the age range of 45 to 64.

Table 3: Age of Household Reference Person for households in which net income falls as a result of personal tax changes in 2008-09 as implemented after 13 May changes

Age of Household Reference Person	Number of households (million)
Under 25	0.1
25-34	0.1
35-44	0.1
45-54	0.3
55-64	0.5
65 and over	0.1
Total	1.1

Source: Ev 133

Mr Brewer agreed that many losing individuals were in households containing other people:

Even the single adults under 25 that we identified we know that the vast majority of those are not living in households by themselves, they are living in households with other people, whether that be sharing a flat with their peers or sharing a house with their parents, so some of those young adults may be able to cope with the slight rise in their income tax bills because the people they live with are facing lower tax as a result of the Chancellor of the Exchequer's measure.[243]

The Chancellor of the Exchequer indicated that around 200,000 of the losers were in households where at least one person paid income tax at the higher rate.[244]

THE IMPACT ON OTHER BASIC RATE TAXPAYERS

89. The increase in the personal allowance also meant that some who had gained from the measures announced in the 2007 Budget gained further. The IFS provided the following figures as to those who gained:

Most people aged 65 or over, and those with non-savings income between £5,435 and £6,635 or between £13,355 and around £40,000, are now paying less income tax. The biggest gain is £457 a year at an income of £36,140.[245]

Mr Chote then pointed out that this meant that a significant amount of the money spent on this measure was not targeted at those who had lost:

Of the £2.7 billion, roughly £2 billion of that has gone to people who did not need to be compensated. So roughly £700 million of the £2.7 billion has gone to the people who were still losers, the 5.3 million families that we were talking about originally, and £2 billion to a wider range of middle-income households.[246]

The SMF highlighted the difficulties of targeting such a reform, telling us that "because of the difficulty of targeting such a universal increase in the personal allowance, this is an expensive way to compensate the losers although it is relatively simple".[247]

90. However, the decision to benefit those who did not necessarily lose from the original reforms was a deliberate one. The Chancellor of the Exchequer in his 13 May statement said that:

The Chancellor of the Exchequer then defended this decision in oral evidence, providing the following explanation:

A number of members of this Committee and other Members of the House have said, "Why didn't you just confine what you did to help those who had lost out? Why did you go further?" I wanted to go further because I recognise that especially this year there will be many people on middle and low incomes who will be facing increased bills for gas and electricity and so on and I believed that it was better, therefore, to allow this additional help to go to all basic rate taxpayers. In doing so it supports the economy.[249]

91. The LITRG suggested that the increase in the personal allowance would mean that some of those aged 60 to 64 claiming the guarantee element of the Pension Credit, who might gain from the additional personal allowance, by doing so may lose their right to so-called 'passported' benefits—in other words, those entitlements, such as free school meals, eligibility for which is determined by eligibility for certain mainstream benefits or tax credits.[250] The LITRG explained why this might happen:

People in the 60 to 64 age group are entitled to claim the guarantee element of Pension Credit. Therefore, some of these people would have paid more tax as a result of the withdrawal of the 10% rate, but would have been wholly or partly compensated by the fact that the reduction in their net income increased their Pension Credit entitlement, or indeed brought them into Pension Credit entitlement. Raising the personal allowance will cause some whose net incomes gave them a Pension Credit entitlement to lose that entitlement and the passported benefits that go with it. However, in tax terms, they will be better off because at those levels of income (approximately £6,500 to £6,700 a year) they will pay less tax than in 2007-08.[251]

However, the Treasury claimed that the impact of the 13 May changes on these people would not be great:

The personal allowance change can only affect Pension Credit where someone aged under 65 is part of a claim, and as with Housing and Council Tax Benefit not all these people will be taxpayers. Guarantee Credit rose by £5 between 2007-08 and 2008-09, whilst the increase in the personal allowance for basic rate taxpayers is worth just over £2/week—so the personal allowance change alone would not taper individuals off Guarantee Credit. In addition, pensioners aged 65 or over normally have a 5-year Assessed Income Period (AIP), meaning they do not need to report changes to their retirement provision (income from capital, annuities or pension) that occur within those five years. Couples where one pensioner is over 65 and their partner under 65 are also eligible for an AIP. Overall therefore the effect of the increased personal allowance in 2008-09 on Pension Credit claimants is likely to be small.[252]

THE IMPACT ON HIGHER RATE TAXPAYING

92. As we have already discussed earlier, the measure announced by the Chancellor of the Exchequer on 13 May was designed to not benefit those on higher-income tax rates. He provided the following reasoning for this omission:

Higher rate taxpayers were largely unaffected by the reforms that were announced last year. So it is fair to focus this additional support on basic rate taxpayers only. However, as the £600 increased personal allowance applies not just to basic rate taxpayers but also to those paying tax at a higher rate, I am reducing the threshold at which an individual starts to pay tax at the higher rate by £600.[253]

By reducing the higher-rate tax threshold by £1,200 from £36,000 to £34,800, higher-rate taxpayers are prevented from benefiting from the measure.[254] What they gain from the rise in the personal allowance, is taken away by having to pay the higher-rate on more of their income. By reducing the higher rate threshold, the Treasury estimated that it had saved around £0.6 billion.[255] However, by lowering the higher-rate tax band threshold, the Treasury also estimated that around 150,000 basic rate taxpayers would be brought into the higher tax band, but stated that "all basic rate taxpayers brought onto higher rate tax by this change will gain by up to £120 from the increase in the personal allowance".[256] Although these new higher-rate taxpayers will not immediately suffer financially, they could suffer from a higher reporting burden. Mr Whiting also told us that it might have an impact on saving:

In terms of burdens, of course at the end of the day they will still see a reduction but not as much as the £120 given to somebody on £25,000, for the sake of argument; they will do better than somebody on £50,000 who is left unaffected. The people in this band, it has already been highlighted, might start contemplating putting more into their pension fund because some of their income at least is being taxed at 40% so they will undoubtedly focus on this. This is nothing new as more and more people are being drawn into the 40% band.[257]

THE IMPACT ON ALIGNMENT OF TAX AND NATIONAL INSURANCE

93. We noted earlier that one feature of the 2007 Budget was a programme to align National Insurance contribution thresholds with those for income tax rates by April 2009.[258] However, the 13 May changes to the personal allowances and higher-rate tax band threshold have placed a question mark over this process. The LITRG pointed out that "The increase in the personal allowance on its own also reinstates the misalignment between the starting threshold of income tax and Class 1 primary and Class 4 National Insurance Contributions, a disparity which has been removed in recent years".[259] Mr Whiting set out his view as to what had happened to the alignment project in the face of the 13 May announcement:

It left it behind! It is one of the problems and I think a number of us as soon as we heard about it started wondering, 'Just a minute, does this mean the national insurance threshold is moving?' Of course, with the emphasis on the benefit being £120, national insurance is left to one side. It will cause confusion for a number of low-paid people who now find themselves paying national insurance and not income tax but, then again, that was always the case and because of national insurance being on a weekly basis rather than cumulative, many of the low paid were already in that situation of paying national insurance when they are in work, in and out of income tax, and at the end of the year paying nothing.[260]

The ICAEW expressed concern at the lack of information on what would happen to the alignment project:

The Chancellor of the Exchequer's announcement said nothing about NIC. The increase in the personal allowance means that this is no longer aligned with the primary threshold for NIC It seems likely that the change in the higher rate threshold for income tax will also have an impact on the Class 1 NIC upper earnings threshold since the Government's stated aim is to align the two. We are concerned that this announcement will have far-reaching consequences for the wider tax system which need to be properly analysed and consulted upon.[261]

94. In response, the Treasury stated that "The Government is continuing to look at the scope for further alignment of the tax and [National Insurance Contributions] systems, taking into account the changes made on 13 May, in future Pre-Budget and Budget Reports".[262] On 5 June, Jane Kennedy MP, the Financial Secretary to the Treasury, when asked about alignment in the light of the 13 May announcement, said "I am … not in a position to say exactly what we will do when we come to consider the rate of national insurance later this year".[263]

95. The SMF concluded that, should the alignment not proceed, "this effectively reintroduces some of the complexity that Budget 2007 had aimed to remove".[264] The IFS, however, outlined some of the costs associated with alignment of National Insurance Contributions thresholds with personal allowances following the changes announced on 13 May:

Aligning the [National Insurance Contributions] earnings threshold with a maintained and uprated higher personal allowance would be extremely effective at removing losers from the abolition of the 10% band (the number would fall to 0.3 million), but at an additional cost over and above that of maintaining the higher personal allowance of £1.5 billion in employee [National Insurance Contributions] and £1.8 billion in employer [National Insurance Contributions]—thus more than doubling the cost in total. Lastly, freezing the personal allowance but increasing the NI earnings threshold to it is more costly than only indexing the personal allowance (because of the extra employer [National Insurance Contributions] revenue lost) but does lead to more families being winners.[265]

The IFS also canvassed some other policy options, including the freezing of the personal allowance in future years and then aligning the earnings threshold with it, and the Upper Earnings Limit with the new higher-rate threshold:

This would increase income tax bills but reduce [National Insurance Contributions] for basic-rate taxpayers … If the new higher personal allowance were frozen, then the number of losers from the abolition of the 10% band would rise to 2.2 million; alternatively, a small rise in the rate of employee [National Insurance Contributions] would make this figure 1.5 million. Compared with the position if the 2008-09 personal allowance were maintained and conventionally uprated, freezing the personal allowance would create 8.3 million losers and increasing [National Insurance Contributions] 9.6 million losers, compared with 3.0 million if the personal allowance were indexed (many additional families would lose by less than £1 a week, which we count as being broadly unaffected).[266]

Conclusions

96. The Chancellor of the Exchequer's letter to the Chairman of this Committee of 23 April referred to the possibility of taking action in response to concerns about the removal of the starting rate of income tax through the mechanism used for making winter fuel payments, through changes to the National Minimum Wage for young people and through Working Tax Credit. With regard to changes to be implemented in 2008-09, the Chancellor of the Exchequer was right not to pursue any of these options. The problem was with the tax system, and required a tax solution.

97. In terms of the changes to be made to the tax system, the choice faced by the Chancellor of the Exchequer was, in Mr Chote's words, "between something that was cheap and complicated or something that was simple and expensive".[267] The Chancellor of the Exchequer could have chosen to target changes to personal allowances more specifically on those who lost from the removal of the starting rate of income tax, but to have done so would have added to the complexity of the tax system. On 13 May, the Chancellor of the Exchequer made a conscious decision to introduce a broader fiscal measure the benefits of which went well beyond those who lost from the abolition of the starting rate. For the current tax year, in the circumstances which the Chancellor of the Exchequer faced, the option chosen on 13 May of increasing personal allowances, but confining the benefits to basic rate taxpayers, was probably the least bad option, with the benefits of simplicity, transparency and greater incentives to work on the basis that fewer taxpayers face high marginal deduction rates. However, £2 billion of the £2.7 billion committed to that measure in the current financial year is not devoted to compensating losers from the removal of the starting rate of income tax. As such, the option chosen on 13 May represents an allocation of resources which is not directed at the Government's priorities relating to child and pensioner poverty.

98. The changes announced on 13 May place a question mark over the process of alignment of income tax and National Insurance.[268] The Government has failed to clarify whether it remains committed in principle to the aim set out in the 2007 Budget of aligning income tax thresholds with those for employee National Insurance Contributions. We recommend that it clarify its intentions no later than the 2008 Pre-Budget Report. Assuming that it remains so committed, we recommend that the Government set out a clear path to full alignment with an accompanying timetable in that document.

99. The Chancellor of the Exchequer made it clear both in his statement on 13 May and in evidence to us that the changes announced relate to the current tax year. For future years he has chosen to emphasise the role to be played by the 2008 Pre-Budget Report.[269] We expect decisions for future years to be taken not in isolation and separate from the normal budgetary processes, but with full regard to the fiscal context and to the broader social objectives which the Government is pursuing, matters to which we now turn.

184 Ev 120 Back

185 See paragraphs 53-54. Back

186 Ev 120 Back

187 Ev 154, 157 Back

188 Ev 83 Back

189 Ev 95 Back

190 Ev 120 Back

191 HC Deb, 23 April 2008, col 1302 Back

192 See Ev 90-94 for analysis by the SMF of these options. Back

193 Ev 117 Back

194 Q 8 Back

195 Q 40 Back