Budget 2014: distributional implications

Speaking before Budget 2014, John Swinney declared the Budget was the Westminster Government’s ‘last chance to seriously tackle inequality’. Early in his Budget speech, George Osborne argued that ‘income inequality is at its lowest level for 28 years’, so he clearly agrees that it is an important issue[i]. But did the Budget measures do anything to improve this statistic further?

Beyond the headlines about savings and pensions, there was little in this Budget for those on low incomes. The Chancellor confirmed the expected rise in the personal allowance (the amount you can earn before paying any income tax) to £10,500. Compared to the current personal allowance of £9,440, this will equate to a reduced tax bill of £200 for anybody earning more than £10,500[ii].

The rise in the upper rate threshold will mean that people paying upper rate tax will see a further reduction in their annual tax bill of £170, on top of the saving from the rise in the personal allowance. Individuals earning less than the current personal allowance will clearly see no increase in their incomes as a result of these tax changes.

In isolation, these income tax changes are regressive (i.e. they benefit the better-off to a greater extern than they benefit the less well-off). The figure below (click to enlarge) shows how the income tax changes are likely to impact the net incomes of households in each decile of the income distribution in Scotland.

On average, households in the lowest third of the income distribution will see virtually no increase in their net income, as these households pay little tax on average. Households between the fourth and ninth deciles will on average experience a rise in net incomes of between 0.5% and 0.9%. In money terms, households in the middle of the income distribution will be around £175 better off per year, whilst households in the top 10% of the income distribution will be £350 better off (households can of course include more than one taxpayer). Budget 2014 contained no offsetting tax or benefit spending measures to benefit those on the lowest incomes (other than the removal of the 10p starting rate of tax on savings income).

Distributional implications of income tax reforms Budget 2014

Figure notes: Figure shows the impact of income tax changes announced at Budget 2014 on average household disposable income across the deciles of Scottish household income distribution. Source: University of Stirling Tax-Benefit model, based on the Family Resources Survey.

The effect of these changes is clearly to increase income inequality. In his speech however, George Osborne argued that the richest are continuing to contribute the most to reducing the deficit. This point is true to the extent that the richest 10% of households have seen the largest falls in disposable incomes (in cash terms and as a percentage of their income) since the Coalition Government came to power (largely due to the fact that the threshold at which taxpayers become liable for higher rate tax has increased by less than inflation, and some assumptions about the effectiveness of closing various tax loopholes).

But across the rest of the income distribution, the effect of the Coalition Government’s budgets has been regressive, as the Treasury’s own distributional analysis accompanying Budget 2014 makes clear (Figure below – click to enlarge). Furthermore, the Treasury analysis excludes some of the welfare reforms that have been announced but not yet implemented. Thus Budget 2014 will give further ammunition to those who argue for Scottish independence on the grounds that the UK Government does not do enough to address growing income inequality.

HMT figure

Figure notes: Figure shows the impact of modelled tax, tax credit, and benefit changes since June Budget 2010, including measures announced at Budget 2014, across the income distribution. The net impact for each decile is given by the black line, and the bars show how this net impact is composed of changes to direct tax, indirect tax, and tax credit and benefit changes separately.

[i] Looking at the source of this statistic in the Budget itself, it appears that Osborne is able to make this statement because he is looking at the ratio of incomes at the 80th percentile to those at the 20th percentile, effectively ignoring changes in income among the poorest 20% and richest 20% respectively.

[ii] The personal allowance was due to increase to £10,000 in 2014/15 already, so it could be argued that the announcement in Budget 2014 is really just a £500 increase in the allowance.

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