David Cameron has announced two big tax changes this lunchtime: he is raising the amount of money you don’t have to pay tax on (the tax-free allowance) from £10,000 to £12,500, and increasing the amount you can earn before you have to pay the 40p rate of tax.
Under the current system you don’t have to pay 40 pence in the pound on your earnings until you reach nearly £42,000 (the rate doesn’t kick in until £31,865 above the £10,000 tax-free allowance). The overall threshold will now increase to £50,000.
But how much will these two measures cost? Many figures are flying around. On the BBC’s Daily Politics shortly after the speech, Michael Gove, the Chief Whip, said raising the allowance would cost £5bn, and the 40p rate change another £2bn. Andrew Neil suggested the real figures are closer to £8bn and £3.5bn.
Paul Johnson, director of the Institute of the Fiscal Studies and point-man for such debates, then endorsed these figures on The World At One.
Earlier this year his institute published a report on the more expensive, tax-free part of Cameron’s plans. They suggested the move would cost “around £5bn per year in 2014-15 prices” if the rate was raised to £12,500 by April 2020, but much more if the move was more immediate.
“A £2,500 additional increase to the personal allowance in April 2014 would cost around £12 billion per year relative to current plans.”
It is unclear when Cameron is proposing to raise the threshold. The confusion around the figures stems from the confusion over timing. The move would costs less over time because inflation means the change amounts to less.
But if the change is introduced closer to 2015 than 2020 it appears it will cost rather more than the £5bn figure now being accepted (the overall £7 billion figure includes £2bn for the 40p change).
Cameron (and Gove post-speech) committed to the move after another £25bn of cuts – 3% of the UK’s budget – is found at some point in the future. It is unclear when that might be.
The ultimate arbitrator in such tussles are the independent Office of Budget Responsibility, but they told us plans announced at a party conference are “not something we necessarily take on as an official measure”. We will have for the plans to be included in the Autumn Statement, on December 3rd, for the OBR to adjudicate.
UPDATE: The IFS have confirmed their director’s – and the Tories’ – figure of £7bn for the cost of today’s changes. The increase in the tax-free threshold would cost approximately £5.5bn, and the 40p rate change a further £1.5bn.
The report assumes that the increase would not be introduced until 2020-21. A quicker introduction during the next parliament would cost the taxpayer more. The IFS also note that the tax-free allowance was already set to rise to £11,620 by 2020 – today’s commitment is less drastic than it seems.
They also have details on who the tax changes will benefit: