Thursday, May 22, 2008

Clegg’s incentivising incoherence

Ah, Nick Clegg. All the gravitas of Charles Kennedy, all the panache of Ming Campbell. But hey – he’s young and he’s southern and he’s dry! And he’s definitely not David Cameron (although if you squint…)

Clegg’s been having fun this week. First, he lets it be hinted to the Telegraph that he’d support the Tories in a hung Parliament – which of course is to position his party rightwards and to align his party with theirs.

This can only be part of an ingenious strategy to make the Lib Dem vote collapse in the Crewe and Nantwich byelection, and – cleverly thinking longer-term – to make rightish Lib Dem waverers drift over to the Tories and push leftish ones away to Labour. Smart.

And then, Clegg gave a speech on tax:

We already have a radical tax package, cutting the basic rate of income tax to just 16p, to make work really pay for everyone.
And scrapping the unfair council tax, which hurts the poorest the most. … Removing this unfair tax and replacing it with a fair local income tax will massively shift the tax burden away from the poor…
It’s absolutely vital that we make these tax changes if we want to make work pay.

Hmm. I happen to think there’s not a bad case for some sort of local income tax, although given that wealth inequalities are greater than income inequalities, this may not be the pro-poor no-brainer he imagines. But my point is that he contradicts himself. He wants to cut income tax to “make work pay” – but is it only nationally levied income tax that affects work incentives? Why would a local income tax not have exactly the same effect?


He also discusses tax credits. These are a real curate’s egg of a policy. They do achieve a lot of redistributive good – neither the Lib Dems nor the Tories dare to talk of scrapping them – but they’re far too complex both to claim and to administer. And as they’re means-tested, there’s also an issue of work incentives, which is Clegg’s point:

At the moment, for every pound you earn over and above six thousand, at least 31p is lost in tax and National Insurance. But for many, because of the loss of tax credits and means tested benefits like Council Tax benefit, much more is lost. 1.8 million people face an effective tax rate of more than 60%. For the worst affected, the tax rate can be 90p in every pound.

So the Lib Dems would do… er… he doesn’t quite say. In the middle of a passage on public spending and waste, he suggests in an offhand way that they’d “scale back tax credits”. For a little more detail, we need to look at the policy document the Lib Dems approved at their last conference: “Better targeting of tax credits to those on low incomes, by increasing the taper rate.”

Hmm. The taper rate, if there’s any doubt, is the rate at which tax credits are withdrawn as income rises. So what the Lib Dems would do to deal with the high effective marginal tax rates would, yes, make them affect fewer people. But those people taken out of the taper rates will be the better-off ones; the ones who remain will be those lower down the income scale. That’s all well and good if you’re focusing on giving money to them – but it does mean that and the marginal rates these poorer people face will be increased.

This is the trade-off of means-tested benefits: the more people you give them to, the less you can target them on the poor; but the more you concentrate on the poor, the higher the withdrawal rate has to be. And the chief bugbear of Clegg’s speech was not the level of credits received by the poor, but the effective marginal tax rates they pay – which this policy would worsen.

Double piffle.


Christine Melsom said...

Can someone please get a Liberal Democrat to explain their latest Policy paper on Local Government funding?
Policy papers 75 and 81 (they should be read together we are told) speak of LIT and a Land Tax.

They have continuouslyly said that they do not agree with a property tax. So what is land if it is not property?

Alix said...

"So the Lib Dems would do… er… he doesn’t quite say."

Er. Yes he did. Cut the basic rate to 16%. And scrap the flat bands of council tax, which are not related to income, and replace them with an income related tax which will dramatically reduce the impact council tax has on lower earners. So your point appears to be that he didn't state the policy measures closely enough to his analysis of the problem.

On local income tax as a disincentive to work - again, because it would *replace* council tax and be fairer (not hard) than council tax, the overall burden on the lower earner would be reduced and work thereby encouraged. It's misleading to suggest that it's some sort of "extra" tax on income when really it just replaces an antiquated rate-paying system. I happen to think it's got an unfortunate name for this reason. Really it needs a name which tells people it is based on ability to pay - as it stands they're just going to think "oh, another income tax".

On tax credits, I think I dimly see the point you're making (though it's not correct to talk about "marginal rates" with application to the withdrawal rate for tax credits - they're a benefit in the first place; the taper rate used to define them is an internal system, not a "tax rate" imposed on income).

The Lib Dem plans are to remove higher earners from tax credits altogether, and this would indeed have the effect of decreasing the tax credits paid to lower earners. The whole point of the Lib Dem approach to taxation and benefits is to tax people less in the first place, thus enabling them to keep more of their working salaries and be in less need of tax credits. This counters dependency on the state, which is an important goal for a liberal. So it's a scaling back, exactly as Clegg said.

As a lefty who believes the state should have greater control over people's money, I can see why you object, because we're coming from different philosophies. But you're wrong to imply that there's no internal logic to the scaling back of tax credits. Makes perfect sense to me.

Tom Freeman said...

Hi Alix,

My point in the bit you quoted was to query his proposals on tax credits.

I don’t agree with your view that scrapping council tax would mean that the replacement income tax won’t affect work incentives. Taxing some activity – other things being equal – tends to disincentive it. This shift would reduce the cost of living somewhere, although the incentivising effects of that would probably be pretty minimal, and it would increase disincentives to work on the activity (paid employment) that the revenue-raising would be transferred to.

I feel I’m repeating myself, but I think it is a very obvious point. Perhaps I’ve misunderstood your objection. If you cut tax X, then why do the motivating effects of tax Y suddenly cease to apply? There's a difference between overall tax levels and marginal tax rates.

If Clegg wants to cut income tax to increase work incentives, so be it. But he has to accept that his local proposal would have the opposite effect. And however antiquated or unfair the thing it would replace, it is unarguably a tax on income, call it what you like.

it's not correct to talk about "marginal rates" with application to the withdrawal rate

I talk about “effective marginal tax rates”, and two sentences later I do indeed say “marginal rates”, assuming that the shorthand will be clear, and then another two sentences on, I use the full phrase again. Of course tax credit withdrawal isn’t income tax, but for the recipient it effectively is. Clegg uses “effective” himself in this context, and rightly so.

I share your desire to counter dependency on the state, and as soon as the market can guarantee a good living wage to everyone, I’ll seek the abolition of social security. Alas, there are plenty of jobs that would pay too little to support a family even if no tax were paid.

So my other desire is to counter this market failure, and so I do indeed think “the state should have greater control over [better-off] people's money” (forgive the insertion) so that it may help poorer people to have more money, which they themselves can then have greater control over.

I don’t think you’ve addressed my key point: that increasing the tax credit withdrawal rate works as an effective higher rate of income tax, with potential work disincentives – which Clegg says he wants to reduce. That’s the illogic.

Alix said...

"Taxing some activity – other things being equal – tends to disincentive it."

That's exactly the point - all other things aren't equal. If you remove a retrogressive tax like council tax and then tax an activity instead, the net effect is to reduce the burden on the lower earners who were the most disadvantaged by the retrogressive tax. In other words, I suppose your point makes abstract sense, but not realistic sense.

I'm happy to accept that local income tax comes a poor second to Land Value Tax, which we really should push more IMHO and which involves taxing wealth rather than activity. But it's definitely still way ahead of council tax as a net incentiviser on economic activity.

"I talk about “effective marginal tax rates”"

Ok, fair enough. In that case I agree that I definitely haven't addressed your point, because I think your point is sort of... pointless. Scaling back tax credits will indeed lead to an "effective" increase in the marginal tax rate, in the interests of reducing dependency, which you share as an aim. At the same time as this is happening, the actual party tax package itself will reduce the effective marginal tax rate. So your choice to emphasise the negative half of a dual drive to arrive at a fairer, less dependent tax system is just that, a choice, which is odd given that the party's tax package appears to dovetail with your stated aims:

"I do indeed think “the state should have greater control over [better-off] people's money” (forgive the insertion)"

Well, then: one of the sources of funding for the 16p basic rate is the removal of higher-rate taxpayers EXTRA tax relief on pension contributions. This accounts for £4.3bn of savings. Reducing the Capital Gains Tax annual exempt amount gives another £1.7bn. These are both reductions which will affect those with highest ability to pay who currently enjoy an imbalance in their favour in the tax system.

Our original intention was, of course, to also get rid of taper relief on CGT, but that was then nicked by GB for the 2007 Budget. I'm not complaining; it was the right thing to do, it's been done - good. But you can see why I get upset when Labour sympathisers take a complacent and superior view of Lib Dem tax policies.

See the detailed figures of last year's tax commission for the two figures stated above - otherwise out of date, alas (I thought it was better than the present package, even though it only reduced the basic rate to 18%):

Tom Freeman said...

I suppose your point makes abstract sense, but not realistic sense

I love that phrase; I’m going to have to steal it sometime.

But let me try to reduce the abstraction. If you give someone some money – or more accurately stop taking it away – by abolishing council tax, then that of course gives them more financial freedom. They can buy more, save more, or perhaps choose to work less as they have less need for income.

Then introducing local income tax changes the equation again. It reduces the returns they get from working. The fact that their cost of living is also reduced doesn’t affect this disincentive.

I’m not saying that none of these policies has merit, but Clegg’s justification for them seems all over the place. There are downsides that he doesn’t acknowledge. Now, that’s perfectly standard behaviour in politicians, so normally I’d think nothing of it. But in this case, the downside is precisely the problem that he identifies as vital to deal with in justifying the 16p rate.

The same applies to the tax credits thing. Increasing the tape rate to focus on lower earners will reduce “dependency” on credits only among those moderately higher earners who are by nature less dependent on the sums they’ve been receiving.

Yes, I emphasise the negative half; well, it is there. I don’t see a lot of sense in an argument that goes ‘X is bad, especially for poorer people. We must reduce X, so here is one policy to reduce X, another policy to increase X and a third policy to reduce X for middle-income people and increase it for lower-income people’.

(In the interest of balance, I should accept that a Labourite criticising the Lib Dems for a less-than-coherent tax package is like the pot calling the kettle Brown. ‘My team’ has not eaactly covered itself in glory lately.)

Alix said...

I think we are, in many ways, in agreement and you're just being a bit grouchy at the present time for some reason ;-) but I will just make this last point:

"Increasing the tape rate to focus on lower earners will reduce “dependency” on credits only among those moderately higher earners who are by nature less dependent on the sums they’ve been receiving."

Well, that is kind of what we want, right? Of course people who really *need* benefits are allowed to be dependent!

One possibility we haven't discussed, though I can hardly claim it as a point because I don't know whether it's our tax policy or not, is that the effects of raising the taper rate could be countered for the lowest earners by raising the exempted threshold. This could be funded by the savings one would make by raising the taper rate.

There's no fiscal reason why we wouldn't consider it, since our tax package is self-contained and doesn't in any way rely on the scaling back of tax credits. I may try and find out...

Tom Freeman said...

We probably do agree more than we thought, and I swear I'm not as grouchy as I seemed. Actually in quite a good mood this week. (One of the problems with critical posts is that they come across as kind of, well, critical.)

Possibly I didn't help matters by opening with the gratuitous insulting of your leader and his predecessors. Let's just agree that David Cameron is a frightful toff and leave it at that ;-)