Tuesday, April 10, 2012

The politics of tax cuts

One of the most interesting features of politics in the UK and US over the past few years has been the politics of tax-cutting. Thatcher and Reagan appeared to make big political gains out of it, and here New Labour was so spooked by the tax issue that they committed to not raising income tax. The interesting point is that tax cuts play well politically even though they are, almost by definition, regressive. The personal allowance change in the last UK Budget is a wonderful illustration of this. By raising the tax threshold, the Conservative-Liberal Democrat government was able to claim to be taking low-income families 'out of tax'.  In a sense, this was true (although only in a sense - income tax is only a small part of the tax burden of the low-paid). But, if we take the bigger picture into account, it is no longer true in any reasonable sense.

The first point about all this is that tax cuts tend to benefit every taxpayer proportionately, which means that their effect is regressive - high income groups pay more tax, and if there is a proportionate tax cut, most of the cut will therefore go to them. In the case of the UK budget, there was an adjustment to higher rate tax thresholds to limit the benefit to higher-rate taxpayers, but the raising of the tax threshold otherwise benefited all income tax payers.

The second point is that poorer families tend to have fewer taxpayers than wealthier families. The poorest, of course, generally have no taxable income, whilst lower paid workers often are the sole taxpayer in the household. So the benefited of the threshold change has tended to go disproportionately to the middle income household, as the Resolution Foundation show in this chart:

(chart tweeted by James Plunkett of the Resolution Foundation, 21 March)

The third point is that the poorer families tend to consume a bigger proportion of government spending, and the opportunity cost of tax cuts is cuts in government spending, which affect wealthier families far less on the whole (although probably more than they think).

So overall, an apparently progressive measure is in fact rather regressive (and politically astute, since it concentrates gains in the middle-high income group whilst rhetorically evoking help for low paid workers).

What can the left do about this? It's a tricky one. The point is that most people have no real understanding of where government money goes, and therefore underestimate the costs to them of cuts in government spending to pay for tax cuts. People also fail to understand how much most voters are actually subsidized by the wealthy through higher rates of tax - it's in the interests of most voters to vote for higher taxes, provided they are not regressive, yet the appeal of a tax cut is always strong.

So the left has got to dream up ways of making the benefits of tax and spending clearer to people. One thought is the government's recent suggestion to give voters a breakdown of how government spends tax money in their tax demands. Actually, I think that's a great idea! Information about spending, if extended to show exactly how much redistribution people are actually getting through the tax system, could help justify more government interventions. The left has got nothing to hide from voters having more information, since most voters gain from centre-left policies. So my proposal is an estimate of how much government spending people get in their various activities (health, education, pensions, etc) alongside people's tax bills. There must be some neat way of doing it that would get the idea across.