There’s more to reducing poverty than raising the income tax threshold

Tax must be considered alongside pay, in-work benefits and the cost of living if policy changes are to help people in poverty.

Tax must be considered alongside pay, in-work benefits and the cost of living if policy changes are to help people in poverty.  

At the weekend, Danny Alexander, chief secretary to the Treasury, told the Lib Dems’ Spring Conference that he and Nick Clegg are pushing for the tax threshold to be raised to £10,500 in next week’s Budget. And they’re not stopping there. He also announced that they will make further raising the tax threshold to £12,500 a priority in any future coalition agreement negotiation, should there be another hung parliament.

Given that the number of working people experiencing poverty now outstrips those experiencing out-of-work poverty, policies that do more to put cash in the pockets of low-earning families have to be central in any anti-poverty strategy. So further raising the tax threshold must help, right?

For some families it certainly will, but there are two important caveats.

First, 2.5m people have already been taken out of tax altogether by increasing the tax threshold. They will see no further gain from raising it higher. If your concern is boosting the income of the lowest-earning individuals, then the limits of this policy have already been reached for a growing number of people.

Second, tax policy cannot be looked at in isolation. Rather it must be considered alongside pay, in-work benefits like tax credits, and the cost of living. Together these factors determine how much disposable income a family has. To assess the impact of raising the tax threshold in this wider context we can use JRF’s Minimum Income Standard (MIS), which is a benchmark of what the public think every household should be able to buy to achieve an acceptable standard of living in the UK.

Take the case of a lone mother with a one-year-old child. Imagine she uses formal childcare and works full time on an average low wage (to be precise, the mid-point of the bottom half of the pay distribution). Analysis by the Centre for Research in Social Policy for JRF, to be published soon, shows that in 2008, her pay, along with the tax credits she would be entitled to, would give her enough income to afford an acceptable standard of living – in fact, her income exceeded MIS by 6 per cent.

By 2013, a woman in the same circumstances would fall short of an adequate income by 5 per cent. This fall in adequacy is due to a combination of stagnant wages and the declining value of the tax credits received, which have not risen in line with inflation. The increases to the tax threshold have helped, but they have not fully offset the loss of disposable income experienced by this family – as the graph below shows.

The arrival of Universal Credit will further blunt the benefit of tax cuts. This is because eligibility for support to working families on low incomes will be assessed on a post-tax basis. This means that a low-earning household will lose 65p for every £1 it gains from a tax cut.

Tax has an important role in any strategy to tackle poverty. But its impact will be undermined if we neglect its interaction with the benefits system and what’s happening to pay and the cost of living.