The Budget: Poorest could be hardest hit

COMPUTER analysis of the Chancellor's tax changes shows that all households will eventually be hit. But the full implementation of the measures over the next three years may cost the poorest tenth of the population twice as much as the best-off tenth.

It is important to distinguish between this year's and future measures. The net effect of this year's tax changes is only a small loss for all taxpayers. About half of all families will be worse off by a few pence per week. This arises from the freezing of personal taxation allowances this year, which was partly offset by an increase in the width of the lowest, 20 per cent, band of tax.

But the Chancellor's future measures are much more significant, according to analysis using the London School of Economics-Cambridge University tax and benefits computer model. His plans involve a piecemeal set of changes that together will have an important effect on incomes. This package consists of:

No uprating of allowances and thresholds to take account of inflation;

An increase in the rate of National Insurance Contributions (NICs) for the employed and self-employed, representing a further shift from income tax to NICs that has characterised budgets since 1979;

Limiting of the married couples' allowance and the additional personal allowance to relief at 20 per cent;

Limiting mortgage tax relief to 20 per cent;

The imposition of VAT on domestic fuel.

These are all extra burdens of tax on households, to be offset by an increase in the size of the lowest band of tax and by an increase in the tax reliefs for married pensioners (which affect very few people in a narrow income band).

The chart shows how this extra burden of tax would be distributed among UK households if all these measures were introduced next year. Most households in the middle of the income distribution would lose about 2 per cent of their incomes in extra tax under these measures.

However, those in the 10 per cent of households with the highest incomes would on average lose less than this - about 1.5 per cent of their incomes. And those households in the bottom 10 per cent of the income distribution - the poorest households in the country - would on average lose twice this proportion - 3 per cent of their incomes.

The Chancellor has promised to compensate those on social security for the extra VAT they will pay by increasing income-tested benefit rates, but it remains to be seen whether they will be increased by as much as 3 per cent above inflation.

It is unclear whether the compensation will take account of the heating needs of some of the poorest groups - the elderly, the young and the sick.

How will the 20 per cent of families who do not claim their entitlement to these benefits be compensated? Will consideration be given to the low-paid and those with small occupational pensions who do not qualify for income-related benefits but who will face these additional burdens?

The recourse to income-tested benefits to compensate for individual losses due to tax increases has many drawbacks. Not only are some of the most needy groups missed out but the unemployment trap is deepened - higher pay is needed to make work worthwhile if the compensation for a higher VAT burden is only available for those on income support.

One feature of the direct tax proposals is that the impact of each measure on the individual taxpayer is limited. The ceiling on NICs means that the maximum increase in payment is 1 per cent of earnings between the upper and lower earnings limits - pounds 3.64 per week.

The Chancellor himself said that limiting mortgage tax relief to 20 per cent had a maximum effect of no more than pounds 10 per month. Similarly the restriction of the married couples' allowance to 20 per cent has the maximum effect, on higher-rate taxpayers, of pounds 6.60 per week.

None of the changes has the effect of increasing the burden of tax on the better-off by significantly more than on those on low or middle incomes. No doubt this is deliberate. Its effect is to put firm limits on the redistributive potential of the Budget package.

Much of the regressive impact of these plans is due to the imposition of VAT on domestic fuel, since spending on fuel is nearly the same for households at all income levels, once household size has been taken into account. This spending is a much larger proportion of the total resources of the poor than of the rich.

Taxes dressed up as 'green' need also to be justified on distributional grounds, or the poor will pay disproportionately for the 'greenness' of the rest of us. For green taxes to be fair, they must be accompanied by measures that redistribute resources to those on low incomes. And this has not been promised in this Budget.

The author is Director of the Microsimulation Unit in the Department of Applied Economics, University of Cambridge

(Chart omitted)