Budget 2012

Introduction
In response to the Budget, Matthew Elliott, Chief Executive of the TaxPayers Alliance, said:

There is a lot of good news in the Budget for families who have struggled in the recession. The cuts in corporate and top rate taxes will improve the incentive to invest and innovate, meaning higher wages before tax. Then a higher personal allowance will mean they can keep more of the money they earn. Unfortunately some of the money is coming from higher taxes on pensioners; there is no relief for motorists from terribly high taxes on petrol and diesel; higher taxes on tobacco will be a boon for criminals selling dodgy cigarettes; and yet another higher rate on Stamp Duty is an unfortunate hike in an ugly tax. But overall this is a Budget that should ease the pressure on peoples living standards and allow most of them to keep more of their money.
This report provides further analysis on a number of the changes made in the Budget. It looks at the following areas: 1. Easing pressure on living standards 2. The personal allowance and marginal income tax rates 3. Age-related allowances 4. Progress towards merging Income Tax and National Insurance 5. Contributing to the illicit trade in cigarettes

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Budget 2012

1. Easing pressure on living standards

The critical challenge for the Government as it attempts to restore the public finances to health while maintaining economic growth is to ease the pressure on living standards. There are essentially three ways that pressures on living standards can be eased: Higher pre-tax incomes Lower taxes Lower prices

Tax changes can increase pre-tax incomes if they increase the underlying rate of productivity growth, or if they cut taxes on business where the incidence is likely to be on workers in the form of lower wages. There are two key measures that will increase pre-tax incomes: the cut in Corporation Tax rates to 22 per cent by 2014-15; and the cut in the additional rate of income tax to 45 per cent in 2013-14. There is extensive evidence that the incidence of corporate taxes is largely on labour in the form of lower wages. For example, a 2006 US Congressional Budget Office report found that domestic labour bears slightly more than 70 per cent of the burden of the corporation income tax.1 In a study for the OECD, Johansson et. al. report that higher top marginal income taxes reduce total factor productivity growth. [Industry-level] evidence covering a sub-set of OECD countries suggests that there is a negative relationship between top marginal personal income tax rates and the long-run level of [total factor productivity]. And Gemmell et. al. have looked at the impact of corporate taxes on productivity. They found that a five percentage point cut in corporate tax rates would increase total factor productivity by 3.8 per cent in the long-run. That effect occurs relative quickly (within 4-5 years rather than over decades) and firms in innovation intensive industries are affected more severely. Higher corporate tax rates, via their effect on the post-tax user cost of capital, have significant adverse effects on firms investment levels.2 As a result, we can expect that the measures announced at the Budget will increase pre-tax incomes, but less than if there were more substantial cuts to Corporation Tax or top

Randolph, W. C. International Burdens of the Corporate Income Tax, August 2006 Gemmell, N., Kneller, R., Sanz, I. & Sanz-Sanz, J. F. Corporate Taxation and the Productivity and Investment Performance of Heterogeneous Firms: Evidence from OECD Firm-Level Data, Documentos de Trabajo FUNCAS, 2010
2

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Budget 2012 marginal tax rates, or cuts to other taxes where the incidence is on labour such as Employers National Insurance. Cuts to Income Tax such as the increase in the Personal Allowance, covered in the next section, will mean a larger share of those pre-tax incomes remain with taxpayers. However that is not true for those pensioners who do not receive an age-related allowance. Prices are likely to rise as a result of the changes announced thanks to a rise in taxes on motor fuel; tobacco and a number of other products (including those now being included in VAT). Overall the Budget should ease the pressure on living standards for most families, particularly over time as higher productivity growth increases wages.

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Budget 2012

2. Personal allowance and marginal income tax rates

To understand the full picture about how marginal rates have changed over time it is necessary to adjust thresholds for changes in average earnings and add together all three taxes on earned income: Income Tax, Employees National Insurance contributions and Employers National Insurance contributions. That means we get a complete picture of the marginal tax rate on labour income and correct for fiscal drag, as tax thresholds become less valuable with rising earnings over time. Changes to the Personal Allowance and the additional rate of Income Tax were announced at the Budget: Personal Allowance 2011-12: 7,475 Personal Allowance 2012-13: 8,105 Personal Allowance 2013-14: 9,205 Additional rate of Income Tax: 50 per cent down to 45 per cent, starting in 2013-14

That will mean that the combined marginal tax schedule has changed in a number of ways, shown in the graph below:

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Budget 2012 The higher rate starts earlier at around 43,000 of earnings rather than around 49,000 in 200102 (adjusted for 2013-14 average earnings). Marginal tax rates for all those earning above the Personal Allowance earners have increased substantially. Those earning at the basic rate pay around 40 per cent and those earning above the higher rate threshold pay around 50 per cent, including national insurance contributions. The increase is largely due to an increase in the rate of Employers NI contributions. There are much higher marginal rates between 107,000 and 122,000 and above 150,000 thanks to the clawing back of the personal allowance and the additional rate respectively. When combined with national insurance the 50p rate is actually a marginal income tax rate of nearly 60 per cent. With the new 45p rate, it will be nearly 55 per cent in 2013-14.

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Budget 2012

3. Age-related allowances
Two groups are affected quite differently by these changes: those who are 65 already or turn 65 in 2012-13; and those who turn 65 in 2013-14 or later. Those who are 65 already, or turning 65 in 2012-13 Those born on or before 5 April 1948 will still get a special age-related personal allowance. It will be frozen at 10,500 for those born between 6 April 1938 and 5 April 1948. And 10,660 for those born before 6 April 1938. Those people are worse off than they might have expected to be, in that the allowance wont rise with inflation. That is unfortunate given the pressure on savers already but they arent actually having their allowance cut from the existing rate. Those turning 65 in 2013-14 or later Those born on 6 April 1948 or later wont get an age-related personal allowance. In 201314, they will get the same personal allowance as everybody else 9,205 instead of 10,500 if they had been born earlier. That implies they will get 1,295 less in personal allowance than they would under the current rules, which means they are about 259 worse off at the basic rate of tax. They will only receive the same treatment as those who have already reached 65 when the personal allowance, which the Government are expected to keep increasing, catches up with the frozen age-related allowances. The Chancellor of the Exchequer made a powerful case in his Budget speech that removing the age-related allowances would produce a simpler tax system. But, particularly for that group now not getting an age-related allowance who expected to get it, that simplicity is being achieved at the expense of a substantial rise in taxes for many struggling elderly people from what they would have expected to pay. That wont affect the many pensioners who dont earn enough to exceed the Personal Allowance anyway. But for some it will be quite tough. It could have been fairer to either: Increase the age-related allowances in line with inflation, and let the working age Personal Allowance catch up as it increases above inflation. Or, just freeze the age-related allowance and let the increase in the working age Personal Allowance erode the difference without cutting it off for new entrants.

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4. Progress towards merging Income Tax and National Insurance

Before Budget 2011, it was reported that the Chancellor was considering merging Income Tax and National Insurance. However at the Budget he announced a more moderate alignment of the operation of the two taxes. Two objections to an actual merger of the two taxes are normally most important: It might result in pensioners and the self-employed paying more. It would end the contributory principle where benefits are tied to contributions.

The TaxPayers Alliance has produced research showing how a complete merger of Income Tax and National Insurance is possible without disadvantaging pensioners and the selfemployed, and arguing that the contributory principle does not exist in a meaningful way.3 Changes to benefits announced at the budget would make a full merger easier: Reforming the State Pension into a single tier pension for future pensioners will reduce the need for a record of National Insurance contributions. The additional transparency with annual tax statements will be a critical opportunity, which the Government should look to take, to make clear that the burden of Employers National Insurance falls on labour. This should, more broadly, be a part of ensuring that those statements do not just provide greater clarity over the taxes people pay directly, but also informing them about the range of taxes they pay indirectly through lower earnings or higher prices.4

Available to download from: http://www.taxpayersalliance.com/nicit.pdf The TPA Tax Buster App illustrates the full extent to which taxes make it harder for people to afford a range of goods: http://tpataxbuster.co.uk/
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5. Contributing to the illicit trade in cigarettes

The Chancellor decided to increase the duty on tobacco by 5 per cent above inflation. Tobacco duties are probably the single most regressive taxes there are, disproportionately affecting people on lower incomes. For many smokers it will account for all or most of the saving from the decrease in direct taxes between 2011-12 and 2012-13:
Gross income Annual Income Tax and NI, 2011-12 40 840 2,440 4,040 7,240 10,440 14,390 Annual Income Tax and NI, 2012-13 0 670 2,270 3,870 7,070 10,270 14,220 Tax cut The extra cost of smoking 20 a day 135.05 135.05 135.05 135.05 135.05 135.05 135.05 New saving The extra cost of smoking 40 a day 270.10 270.10 270.10 270.10 270.10 270.10 270.10 New saving

7,500 10,000 15,000 20,000 30,000 40,000 50,000

40 170 170 170 170 170 170

-95 35 35 35 35 35 35

-230 -100 -100 -100 -100 -100 -100

This is not the first time that tobacco taxes have been increased substantially above inflation, but such tax hikes can increase the trade in illicit substitutes. A World Health Organisation report in 2004 found that:5

In 1998 and 1999, taxes increased by 5% over inflation, but revenues declined because of continuous growth in smuggling. By 1999, the revenue lost through tobacco smuggling was estimated to be about 25% of all tobacco revenue.
Another study in 2004 found that the tax avoidance response to tax changes is at least twice the consumption response. That is the equivalent of two people simply switching to the illicit market for every one person who stops smoking because of higher prices. This is a serious problem in other countries, too. In the 2010 Irish Budget, the Minister for Finance Brian Lenihan froze the duty on cigarettes. He outlined in his speech why:6

I have decided not to make any changes to excise on tobacco in this Budget because I believe the high price is now giving rise to massive cigarette smuggling. My responsibility as Minister for Finance is to protect the tax base. I have full confidence in the effectiveness of

5 6

World Health Organisation Taxation of tobacco products in the WHO European Region: practices and challenges, 2004 Brian Lenihan T.D. Financial Statement of the Minister for Finance, 9 December 2009

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Budget 2012

the current multiagency approach but early in the New Year I want to explore what further measures we may need to stem the illegal flow of cigarettes into this country.
That was a frank acknowledgement that the high duty on cigarettes had not necessarily curbed consumption but had led consumers to purchase substitute illicit goods instead. Gabler and Katz carried out a study in Canada in 2010 and their findings were stark:7

Contraband cigarettes are perceived to be a nearperfect substitute for lawfully purchased cigarettes. As such, contraband tobacco use neutralizes the deterrent effect of higher taxes.
When taxes on cigarettes were increased in 2002 in New York City, the combined state and local taxes were $3 a pack. But during the four months that followed, sales of taxed cigarettes fell by 50 per cent compared to the same period the previous year.8 It is not plausible that this was due to a fall in the number of smokers; again it suggests that the measure was a considerable boon to the illicit market.

Gabler, N. & Katz, D. Contraband Tobacco in Canada: Tax Policies and Black Market Incentives, Studies in Risk and Regulation, Fraser Institute, 2010 8 Fleenor, P. Cigarette taxes, black markets, and crime lessons from New Yorks 50-Year losing battle, Cato Institute Policy Analysis number 468, 2003

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