Give the poor a tax cut

Reducing the tax burden on the less well-off is a good way to boost economic growth, says Matthew Lynn.

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We have yet to see the full manifestos of the main political parties for the general election. But none it seems will be offering any significant cuts in the burden of taxation. That's a shame because, as a new study shows, cutting taxes on the poor is a good way to boost economic growth.Owen Zidar, an assistant professor of economics at the University of Chicago Booth School of Business, looked at tax cuts in the US for the postwar period, then at their impact on different states. He found that a lot more jobs were generated in the poorer states for each tax cut than in the richer ones.

"Tax cuts that go to high-income taxpayers generate less growth than cuts for low and moderate income taxpayers," he concludes. "In fact, the positive [overall] relationship between tax cuts and employment growth is largely driven by tax cuts for lower-income groups and the effect of tax cuts for the top 10% is small." The explanation is that the poor spend a lot more of any extra dollar they receive and that generates more demand. And, at the margin, each cut has a bigger impact on the incentive to work for people lower down the earnings ladder.

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It is unlikely the results would be any different in the UK. Tax cuts would have more impact in Newcastle than Newbury, in Swansea than Swindon. If the economy remains resilient, and the budget deficit keeps coming down, there are three areas where we could focus tax cuts as the money becomes available.

First, we should carry on raising the starting threshold because that takes people out of the tax net. The previous coalition government made progress on that, taking it all the way up to £11,500, from less than £7,000 when Labour was last in power. That took four million people out of the tax net completely. But that is no reason not to go higher there is no greater incentive to work than to pay no tax at all on your earnings.

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We should look at cutting the standard rate as well. That was last cut way back in 2007 when Gordon Brown reduced it from 22% (although he threw in a few stealth taxes to make up for it). That is a long time, and other taxes have come down all around it. In particular, the corporation tax rate is scheduled to come down to just 17%. It doesn't seem right that someone raising a family on £30,000 a year should pay a higher rate on their earnings than Tesco or Barclays or the self-employed person next door who has turned themselves into a company. Why not match up the basic and corporate rate?

Finally, when public finances allow it, we should look at taking VAT back to 17.5%. It was pushed up to 20% in George Osborne's first budget as an emergency response to a deficit that threatened to spin out of control in the wake of the crash. But while VAT is an efficient tax, there can be no question that it falls mostly on the poor, simply because they spend a greater share of their income. The emergency has surely now passed, with the deficit back to manageable levels. That makes it a good time to start getting back to the old rate.

There are other moves that could be made. If tax cuts for the poor help create jobs, why not target them where work is most needed? Wales is one of the poorest parts of the country, so why not let it have a slightly lower rate of income tax? The same could be true of the northeast. And Scotland, of course, already has the power to reduce income tax it is just that the SNP does not use it. Tax cutting has not featured enough in the election campaign so far. But if it does, let's hope the promises focus on cutting taxes for the poor because that is where it will have the greatest impact.

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