It pays to cut taxes

By Madsen Pirie (July 3 2008)

One of the tests by which the next government is judged will be on what it does to benefit poor people. This government was big on talk, and even bigger on complexity, but woefully short on substance. An effective proposal would be to take poor people out of paying income tax.

You start to pay income tax at just over £6,000 of earnings. That's way too low. It should be at least £12,500, which is what you get for a normal work-week on the minimum wage, and equals half the national average wage. Someone who earns that little should not pay tax on any of it; they have a hard enough time getting by as it is.

This will cost money, of course. To raise the threshold like that would reduce the Treasury's tax take by billions of pounds. Our accountancy team is crunching out the numbers, and we'll publish the full, costed, proposal in the late summer.

Suffice it to say that some money will saved on the tax credits no longer needed if low earners can keep their own money. There will be savings not just on the payouts, but upon the costly and complex administration which supports them.

There will be more savings, too, on the welfare budget, because work will be more attractive than benefits if we stop taxing it for low earners. People will find it better to take low-paid jobs than to stay on welfare.

This still isn't enough, so we need to have higher earners contribute more, not in terms of their tax rates, of course, but in the total amount they contribute. In the 1980s both British and American high earners paid more in tax (and a greater proportion of the total) when their tax rates were cut. We need to see how we can reduce rates and raise thresholds at the top to pay for lifting the starting threshold to £12,500 at the bottom.

The Treasury will not allow themselves to take such calculations into account, and the Tory tax team has undertaken not to, either. Fortunately we, at the Adam Smith institute, have no such limitations. We also welcome suggestions to improve our study ahead of its publication.

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