Of course he lowered the tax on bingo and beer (the readers of tabloids pay taxes too, and their journalists need something to write about). Beyond that, the change in tax he focused on in his speech was yet another increase in the personal allowance (this time by £500), designed to help the so-called ‘squeezed middle’.
The idea of a squeezed middle may be little more than a clever myth concocted by Opposition leader Ed Miliband and his advisers, but never mind. What is certainly true is that a general election is looming, and the middle is where one goes looking for votes. In the meantime, the drop in incomes at the very top is what until very recently has most hampered efforts to bring the deficit under control.
Between fiscal years 2009/10 and 2012/13, the share of income captured by the top 5 per cent of all taxpayers – those with incomes initially of £63,200 per annum and above – dropped from 26.4 per cent of the total to 23.9 per cent. Indeed, for those with incomes above £149,000, the hated ‘one per cent’, the drop was even steeper, from 13.9 per cent to 11.2 per cent.
Government policy only reinforced these changes. The after-tax share of income for the top 5 per cent dropped from 22.4 per cent to 19.4 per cent, and for the top 1 per cent dropped from 11.2 per cent to 8.2 per cent – a reduction of more than a quarter of their share of after-tax income. By contrast, the half of all taxpayers that populate the middle of the income distribution saw their share of after-tax income rise from 38 per cent to 39.4 per cent.
So although as the economy contracted everyone lost ground, it was those at the top, rather than in the middle, who lost the most. Data on income, net of all direct taxes and inclusive of state benefits, compiled by the Institute for Fiscal Studies, though it only covers the period to 2011/12, paints a similar picture.
According to the IFS, the top 5 per cent saw their net incomes drop by 8.3 per cent, median income dropped by 5.8 per cent, and the drop for the lowest 5 per cent was only 0.7 per cent.
One unheralded effect of the recent downturn, its immediate aftermath, and the government’s efforts to stabilise its own finances, has been the narrowing of income distribution (at least if you ignore differences in price inflation). From 2009-10 to 2011/12, the Gini coefficient dropped from 0.357 to 0.341.
Here you see the reason why the chancellor’s plans to reduce the deficit initially missed their targets. In June 2010, a month after taking office, he introduced his plan under which public debt was meant to top out at 70.3 per cent of GDP in 2012/13, and then begin to decline.
Instead it reached 74.9 per cent in 2013-14. So what went wrong? Partly the economy began to grow much later and much more slowly than initially anticipated. But another reason was the decline in inequality.
To see why this matters, remember that most people who are members of the top 5 per cent face 40 per cent marginal rates for income tax, and if they work, an additional 15.8 per cent in employee and employer national insurance (NI) contributions on their earnings.
In contrast, those at the very bottom are usually below the thresholds for either income tax or NI contributions. Though people generally dislike inequality, from the Treasury’s perspective, every pound of gross income shifted from the top 5 per cent to the bottom 5 per cent means a reduction in tax revenue of more than 50p.
The decline in revenue might have been worse were it not for the squeeze imposed on the rich, and on the merely affluent as well. The previous government introduced the additional rate tax at 50p. When combined with NI contributions, the tax rates on earnings above £150,000 exceeded 60 per cent. As anticipated, the effect of raising the tax rate so high was neutralised by the disincentives it created.
Rather than abolish the tax, this government reduced it to 45p, and combined with NI contributions, the marginal rates for people with the highest incomes are now 55.8 per cent.
Research suggests this is close to, but does not exceed, the rate that brings us to the point where tax rates and tax revenue are inversely related. So while setting rates any higher would prove counterproductive, one way to raise more revenue is by sweeping more people into this upper band. By not adjusting the threshold of £150,000, that is what the government is doing.
The number who paid the additional tax rate last year reached 313,000, an increase in three years of nearly a third, with each on average paying £154,000, or 38.2 per cent of their income. This amounted to £48.4bn and comprised 29 per cent of all income tax collected, up from 24 per cent in 2010, when £37.5bn was collected.
However, not all this increase was generated by the additional tax itself. Instead, about £2.1bn of the extra £10.9bn was raised by subjecting a larger share of these people’s incomes to the slightly lower 40p rate.
That is because this threshold has not merely remained constant in nominal terms, but has actually been lowered successively over the past three years from £35,000 to £32,010, drawing an extra 830,000 into the ranks of higher-rate taxpayers.
This year the threshold is down to £31,865, and it will drop still further in 2015/16 to £31,785, allowing more people to feel, as the chancellor reportedly told Tory MPs, “they are successful”.
In the meantime the economy grew faster than the population last year, for the first time since 2007. Between December and March, the Office of Budget Responsibility has raised its forecast for this year’s growth from 2.4 per cent to 2.7 per cent.
Inequality is coming back as well. The share of gross income going to the top 1 per cent has increased from 11.2 per cent to 13 per cent, and for the top 5 per cent, from 23.9 per cent to 25.4 per cent. While the burden of public debt is still not expected to begin dropping until the next fiscal year, the OBR also revised, this time downward, its forecast of debt to GDP from 80 per cent to 78.7 per cent.
For years the government’s critics have argued that its policy of austerity was misguided because it would not generate economic growth. This was deeply disingenuous – austerity was never meant to foster economic expansion, but avert a looming sovereign debt crisis.
But this argument works both ways. Years of the chancellor’s Budget cuts are not directly responsible for the relatively high rates of growth the UK is now enjoying – at least compared with other large economies.
Furthermore, it is not just the expansion of the economy but rather the way so much of it is benefiting those who pay the most taxes that is helping to bring the deficit under control.
That is the part about deficit reduction you did not hear about in George Osborne’s budget speech.
Michael Ben-Gad is professor of economics at City University
Key points
* The focus of the Budget was another increase in the personal allowance to help the so-called ‘squeezed middle’.
* Most people who are members of the top 5 per cent face 40 per cent marginal rates for income tax.
* The Chancellor’s budget cuts are not directly responsible for the relatively high rate of growth in the UK.
