A budget to reward work?

Politicians are always looking to incentivise employment. The general means of accomplishing this is by either cutting taxes on high earners and corporations to encourage entrepreneurship or cutting benefits to get the unemployed off the dole and contributing to GDP and tax revenue. In the run up to today’s third budget of the coalition government Chancellor George Osborne claimed he was planning a “budget to reward work”, i.e. one which will benefit those already in employment and encourage the unemployed to get a job.

Now with the details of the next 12 months of government spending announced we can ask ourselves: to what do degree has he succeeded? There was some welcome news, such as raising the level at which someone in employment begins to pay income tax to £9,205 a year with the aim of raising it to £10,000 next year. Not only will this reduce the tax burden on those with the lowest incomes but all those in employment will pay less tax; the average basic rate tax payer will now be £305 a year better off. This may not sound like a lot but it will boost consumption and aid the economy. Another good idea was tax breaks for firms working in the fields of computer games, animation and high end television manufacture. These are important sectors to the UK economy where we have a competitive advantage and are vital to our growth.

However, over the last year those in employment have had their prosperity dogged by the spectre of inflation above the Bank of England’s target. Although inflation has fallen back in the last few months (currently the CPI is at 3.4%) higher inflation erodes the value of income made from working and reduces the incentive to enter work. Firms have tended to give lower than inflation pay rises recently so as inflation remains high and those in work are finding themselves worse off. Inflationary pressure is largely the result of rising fuel costs caused by the soaring price of oil and gas on the global market. A domestic fuel subsidy or measures to reduce transport costs could have reduced inflationary pressure and made the income from work more valuable. This, however, was never on the agenda.

Another consideration is where will the funds come from to pay for this tax reduction? Borrowing is projected to be £1bn lower than anticipated which has given the Chancellor room to manoeuvre. A certain amount of the slack will be taken up by the rise in stamp duty for properties over £2m and the proposed clamp down on tax avoidance. The majority of the additional revenue will be raised by an extra 37p per unit tax on cigarettes. It is worth remembering that taxes on commodities disproportionately affect low earners as they spend a higher proportion of their income on the taxed commodity. A tax break for lower earners could be a double edged sword for those who also smoke – which there is also a higher instance of among the poor.

The other main highlight of the budget was the reduction in the top income tax bracket - from 50p in the pound to 45p – aimed at encouraging entrepreneurship and investment from overseas. I have blogged about this before but investment will remain low and the rate of business start ups will be sluggish while GDP growth is lack luster. With growth in 2012 projected at a mere 0.7%, Osborne should consider a growth strategy if he wishes to stimulate investment and create a fertile environment for new businesses.

Job creation and a plan for boosting growth were not overtly stated in today’s budget. There was protection for some vital areas but others important growth sectors (such as renewable energy) were all but activity discouraged – mainly through the government’s continual commitment to non-renewable energy. Unemployment is projected to hit a peak this year at 8.7% and a clear plan for job creation is needed to protect the recovery. Unemployment and the low growth rate are the biggest problems the UK economy faces right now and the government should commit to a clear strategy for tackling these before it leads to endemic social problems. Such a plan would also send a clear signal to overseas investors and aspiring entrepreneurs that the UK is committed to economic prosperity above political goals.

Overall this is a budget lacking in ambition or a clear plan to boost the economy out of its current dire situation. There were no sweeping cuts, surprise new schemes or massive tax boondocks. Just a few tweaks to the system with the vague goal of stimulating growth and getting more people off benefits and into employment. If Osborne really wanted to create a budget that would reward work he would take measures to reduce inflation or help get more people into work. More employment and a better growth rate would benefit both those in and out of work as it would grow the economy overall. The Coalition maybe attempting to incentivise work but while the economy remains weak, their efforts will be unsuccessful.

50p Tax: What’s going through the Torys’ heads?

It is no secret that the Tories want to abolish the 50p tax band. There are few points more fundamental to Tory ideology than the belief that taxing the wealthy is not only bad for the economy but also morally wrong. It runs to the heart of their belief in individual freedom, economic liberalism and personal responsibility. The most surprising fact about the rumoured plans to abolish the 50p tax rate in the forthcoming budget is that it has taken the Tories the better part of two years in government to consider acting.

This is partly due to their coalition partners. The Liberal Democrats oppose the removal of the tax without the instigation of another tax on the wealthy in its place. They would prefer the Mansion Tax they proposed in their 2010 manifesto – which is also vehemently opposed by grass roots Conservatives. If the Tories were to repeal the 50p tax rate without implementing the Mansion Tax (or something similar) it could derail the coalition’s remaining legislative agenda at a time where Lib Dem support is essential to pass the government’s welfare reforms.

The second reason why the Tories have waited until now to considering removing the tax is fiscal. The government’s argument that the nation’s coffers are in such a dire state that all must make sacrifices for the economic wellbeing of the country carries little weight if it emerges that there is room in the budget to cut a substantial revenue stream. The Conservatives would be on dodgy political ground if as soon as they entered government they cut the essential services lower income earners rely on (such as EMA) and introduced a tax which falls disproportionally on the poor (the VAT rise) whilst also passing a tax break for the highest earners.

Sound economics does also lie behind the decision to keep the 50p tax rate. To reduce government borrowing as quickly as possible, tax streams would have to be kept at the current level or raised – hence the rise in VAT. Income Tax is the largest proportion of the government’s income from taxation, and high earners pay the lion’s share of this income.

So why act now? Again there is an economic case to repeal the tax. Growth has been poor since the coalition came to power, and many think tanks and economists believe that repealing the 50p tax would stimulate consumption of consumer durables (predominantly purchased by high earners) and boost the economy. It would also go some way toward attracting investment from overseas - although investment will be limited whilst growth remains sluggish. The Tories’ re-election and deficit reduction programme depend on growth rising in the next few years, and cutting taxes on high earners is seen as a short cut to achieving this.

There is also pressure to repeal the tax from within the Tory Party. Cameron has a problem with his own right flank, who feel that too many Liberal Democrat policies are on the agenda, that the government has not played hard ball sufficiently with the EU, and that Cameron is not doing enough to protect the international standing of Britain as a great nation. These MPs are also concerned about their own re-election under the Tory banner, and are crying out for some traditional Tory reforms to take back to their constituencies. Cameron’s failure to support the back-benchers’ proposed EU membership referendum has created resentment within his own party, and he needs a bone to throw to them to ensure they keep supporting the continuation of the coalition.

The Tories do have to consider the strong case for keeping the higher tax rate. Firstly, it generates essential revenue at a time when growth is slow and tax receipts are lower accordingly. Another key point to consider is that those who stand to benefit from the repeal of the rate are the very wealthy, and studies have consistently shown that the wealthy save a higher proportion of their income, whereas those with lower incomes spend the majority of their income out of necessity. If the government’s plan is to boost consumption, then conventional logic suggests the amount of money that circulates around the economy should be raised, rather than the amount left inactive in bank accounts.

Aside from this, the government is faced with a moral responsibility that any government should have, which is to help the less fortunate, the vulnerable, and those who cannot look after themselves. This government is failing in that regard as its austerity programme is cutting the services needed most by those whom society is supposed to look out for. To reduce taxes paid by those most capable of providing for themselves at this time would be a failure on a moral level.

If Osborne wishes to abolish the 50p tax band in tomorrow's budget, then he must consider the political fall-out with his Lib Dem coalition partners as well as the wider economic implications. He must also bear in mind that the most obvious logic of cutting taxes to boost consumption does not always hold true. Whatever decision is reached, it will certainly be considered a test of the Tories’ claim that all sections of society must make sacrifices in order to tackle the budget deficit. The Conservatives certainly would love to abolish the top tax bracket; whether they are willing to spend the political capital needed to do so will be a question that can only be answered by Wednesday's budget.