Brown’s “sleight of hand” budget hurts the poor as well as the rich

It came as no surprise that Gordon Brown delivered a few headline-grabbing surprises in his last budget as Chancellor of the Exchequer. By far and away the most eye-catching (though not unpredicted) measure was the grand finale, the cut in the basic rate of income tax from 22p to 20p in the pound. It seems like the tax cut that Middle England has been waiting for, but in truth it is what Menzies Campbell called a “sleight of hand”, giving with one hand while taking away with the other.

Tax measures are never equal, however – there are always winners and losers – and this one appears to squeeze those on low incomes the hardest.

Without having the leisure to browse the Red Book, a brief analysis of the measures looks like this:

• The 10p lowest rate of income tax is abolished, applying the basic rate from the very beginning
• The basic rate is cut to 20p
• The upper rate allowance is set at £43,000 from 2008
• National Insurance is aligned with income tax
• Tax credits are increased

The effect of the first two measures is to take more income tax from the roughly £2,000 one earns after one’s personal allowance is used up, but less from the next £30,000 (or £35,000 from 2008). So an extra 10% of £2,000 but a saving of 2% on £35,000, which means that if you are earning around £40,000 you will pay slightly less income tax, but if you are earning just £10,000 you will pay a lot more.

Ed Balls, the Chancellor’s closes ally, admitted that it was “not a very big tax cut”. It was worse than that, however. The poor are squeezed to pay for an income tax cut for the rich. But the National Insurance changes undermine what benefit higher earners see. By applying the 11p rate of National Insurance on earnings up to £43,000, instead of £35,000, an extra 10% of that last £8,000 is taxed, undermining much of the gain from the income tax cut outlined above.

Thus those earning very little will end up paying more tax, as will those earning a goodly sum. Only those in the very middle appear to gain (though it is interesting to note that other commentators seem to have interpreted this differently, so I would welcome an explanation as to why others seem to think that it is those earning in the twenty thousands who will suffer most).

The budget raises taxes on low-income earners and so presumably raises the barriers to people leaving benefits and returning to work. Brown’s solution is to fall back on his tried-and-tested-and-frankly-failed Tax Credits. He promises to increase the amount of tax credits, but the tax credit system is already costing £16bn and requiring 8,000 civil servants to administer. Yet last year half of the awards were wrong. Furthermore, too many of the poorest do not even claim the benefits, so complicated and obscure are they.

In other budget news, Brown has raised taxes on small businesses while alleviating them on bigger firms. The latter a welcome measure if we are to compete with low-tax emerging economies, but to increase taxes on struggling small enterprises if frankly perverse and pernicious.

Public spending will remain at record highs of 42% – not far off a level where the state takes every other pound we generate to distribute in on our behalf – yet there has been precious little to show for it.

The environmental taxation remains both parlous and interventionist: while the overall level remains lower than under the Conservatives, the measures introduced are meddling (levied specifically at Tory-voting car owners, for example) rather than economically (which is not to say fiscally) neutral (taxing all carbon and so allowing people to decide how to cut back – the policy I have advocated).

Despite the bluster of the Chancellor and the raucous support of his party, this budget is a disappointment. The tax code remains more complex than anywhere but in India as Brown intervenes and meddles in ways that distort the economy and make work for civil servants. It may serve his personal goal of looking good as he moves next door to No. 10, Downing Street, but it does little to address the real problems in Britain: excessive and ineffective public spending, taxes (not just headline rates but overall burdens) that are too high, an over-regulated economy and an underclass of poor people increasingly struggling to provide for themselves and their loved ones.

As an exercise in Public Choice Theory it is exemplary: the politician serves his own interests rather than those of the nation. As an economic plan for Britain’s future it is a sham.