Exploring Tax and Welfare Options

Budgetary policies on income-related taxes and welfare must find a balance between providing income support to those in need and maintaining a financial incentive to work which supports high employment. This paper focuses principally on the "cash" or "first round" impact of tax and welfare policy changes across the income distribution. Incentive issues are considered in Section 5 of this paper, and in a companion paper to this conference (Savage et al., 2015). Our analysis finds that cuts in the top rates of tax and USC would have a strong impact on households with incomes in the top 10 per cent, but little effect on households at low and middle income levels. Tax reductions via the standard rate of income tax would lead to percentage gains in income which were greatest for middle- and upper-middle-income households. Reductions in the "main" 7 per cent rate of USC would see the greatest percentage gains go to the upper middle reaches of the income distribution, but with some benefits for the middle. Increases in welfare payments would lead to gains which were greatest in percentage terms for households in the bottom half, and especially the poorest 30 per cent, of households. In our analysis, several possible budgetary packages have been constructed which are consistent with the Spring Economic Statement, and with stated government intentions regarding cuts in the main (7 per cent) rate of USC. These packages are not predictions of what we expect will actually happen in Budget 2016, nor are they recommendations. Rather, they are intended to give some sense of what types of package might be possible within the overall "fiscal space" indicated by the Spring Economic Statement. One key finding is that, depending on the rate of earnings growth in 2016, between a quarter and a half of the total "fiscal space" might be needed simply to index the tax and welfare systems in line with earnings. A second finding is that with the 50-50 division of the space between tax cuts and welfare increases, the average income tax (including USC) rate could fall, and welfare payments could rise slightly ahead of expected inflation.