Page last updated at 21:32 GMT, Tuesday, 25 November 2008

Average earners 'lose out' in PBR

By Steve Schifferes
Economics reporter, BBC News

Job Centre scene
The government will have to spend more on unemployment because of the slowdown.

A leading think tank, the Institute for Fiscal Studies, says that people on average earnings will pay more tax in 2011 as a result of changes made in the pre-Budget report.

And it claims that it is unlikely that the government will raise any money at all from increasing taxes on the rich to 45p in the pound.

Political controversy has been raging about the tax changes announced in the pre-Budget report.

The Conservatives say that people earning more than 20,000 per year will pay more tax because of planned increases to National Insurance contributions.

The effect of the stimulus and the effect of interest rate cuts are both uncertain.
Robert Chote, director, IFS

The government has said that anyone under 40,000 will be better off because of changes to personal allowances.

The IFS says that the answer depends on which starting point is used.

But as the changes to personal allowances were made in May - to compensate people who lost out when the abolition of the 10p tax rate came into force in April - the IFS suggests it seems odd to use as a baseline a system that only existed for a short time.

These changes were made to help people who had been made worse off by the abolition of the 10p tax rate.

Winners and losers

Distribution of winners and losers

The IFS calculates that, when all tax and benefit changes are taken into account, only people in the bottom 30% of the income distribution would be better off by 2011, while those in the higher income bands would be worse off.

It also points out that the temporary cut in VAT will provide a bigger benefit to low earners, since they spend more of their income, while higher earners save more.

However, because the poor spend more on VAT-exempt items like food, when measured in terms of actual spending, the richer receive a proportionately larger benefit.

The IFS also points out that there is remarkably little in the pre-Budget report that directly helps the poor, and says its expects the government to miss its target of halving child poverty by 2010.

Taxing the rich

The government has also announced that it will announce a new 45p higher rate of tax on people earning over 150,000 in 2011.

John Radcliffe Hospital
Spending on new hospitals and schools will fall in the future

But Mike Brewer of the IFS says that his "central estimate" is that this will raise no additional revenue.

The IFS calculates that most of the rich will be able to avoid paying the higher rate - by putting more money into pensions, working less hard, or moving abroad.

He says there is considerable uncertainty over the "behavioural response" of the rich to higher taxes.

And the IFS points out that, even if the government raises the 1.6bn it hopes from this tax, it will only make a small contribution to reducing the 118bn budget deficit forecast for 2010.

Spending squeeze

The IFS says that the size of the squeeze planned by the government is unprecedented - from adding 19bn to the economy this year, to taking away 22bn by 2013.

But "most of the looming fiscal squeeze comes in the form of spending cuts rather than tax increases."

It estimates that the government plans to cut spending by 37bn, or 2.5% of GDP, between 2011 and 2014.

This is the same figure that Labour accused the Tories of cutting from public spending in the 2005 general election.

In March 2005, Mr Darling described reductions of this size as "so large they could only be found from cutting deep into front line public services, including schools, hospitals and the police".

As a result of the spending squeeze, public spending will grow by just 1.1% in those years, compared with a growth of 2.5% in the current three-year spending round.

And the biggest cut will be in capital spending, such as building roads and schools, which be frozen and fall by 16.5% in real terms.

This is a big reversal of previous commitments by the government to protect capital spending.

Indeed one of the government's key fiscal rules exempted capital spending from the same limits that applied to current spending.

Fiscal rules

These rules have been abandoned by the government during the current financial crisis, and the IFS says that the new "temporary operating rule" is too vague to be of much help to markets.

In particular, argues Gemma Tetlow of the IFS, their hope to "reduce debt as a proportion of GDP once the global shocks have worked their way through the economy in full" gives little guidance as to when exactly the soaring debt level is expected to come down.

Robert Chote, the IFS director, said that "the effect of the stimulus and the effect of interest rate cuts" are both uncertain.

"The concern that a fiscal giveaway could raise the government's borrowing costs and put uncomfortable downward pressure on the pound is of course a serious one," he added.

But he said that on balance, the risk of acting was less than the risk of refusing to act.

Government debt

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