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Tuesday, March 9, 1999 Published at 14:28 GMT

No cheers for 10p tax rate

With the possibility that a 10p tax rate will be announced in the Budget, BBC economics reporter Chris Giles asks whether it will make the tax system fairer or boost work incentives.

Treasury officials privately gossip about the birth of the idea for a 10p, or 10%, starting rate of income tax. It was all a desperate stunt dreamed up by spin doctors to let Labour compete with the Tories on the low tax agenda, they say.

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The Tories had a 20% rate, why shouldn't Labour trump this with a 10p rate? And so the 10% tax rate found its way into the manifesto and now is a core part of the UK Government's tax policy.

In each of his two Budgets so far, the chancellor has reiterated his desire for a 10% rate of income tax "once it is prudent and right for the economy".

This is the real problem for Treasury officials. They know the 10% rate is all about politics and not economics and yet they are the ones who now have to justify its introduction before the next election.

Making work pay?

Gordon Brown has always defended the 10% rate on the grounds that it will make the tax system fairer and will help make work pay for those on low income - giving a much needed boost to work incentives. But where both these aims are concerned, the 10% rate fails.

Fairness is a concept that is almost impossible to define. But if it is fairer if poorer people pay less tax, a 10% starting rate of tax is always less fair than increasing income tax allowances.

The main tax allowance is the 4,045 that anyone can earn before income tax becomes payable. The poorest tax payer would have his or her income tax bill halved with the 10% tax rate, but they would pay no tax at all if the personal allowance were increased. That is more fair.

Fairer still would be to a cut in VAT or an increase in benefits targeted at the poorest families in Britain.

As poorer taxpayers gain more from increases in tax free allowances, it is also true that financial incentives to work for low earners are better served by increases in tax allowances. That way, they end up better off.

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Even so, it would hardly make any difference to the finances of low earning families. When they work, they also receive benefits like Family Credit (to be replaced by the very similar Working Families Tax Credit) which are reduced if tax bills fall.

So for every 1 less tax paid, the family would lose at least 70p in Family Credit, and more if they also receive Housing Benefit or Council Tax Benefit - hardly a transformation of work incentives.

Despite this simple reasoning, there is still a good chance the 10% rate will be announced on 9 March for implementation in April 2000. Then it can be guaranteed to be in place in time for a possible General Election in 2001.

The delay in implementation is almost certainly needed to sort out problems that the new tax rate would create for firms, for the taxation of savings and for taxing married couples.

Expensive remedy

The other big problem with the 10p rate is that it is very expensive to implement, at least in a way that will make a major impact on people's tax bills. Gordon Brown is likely to abolish the current 20% rate first so the 10% rate can apply to a bigger slice of income. But whichever way he plays it, lower rates of income tax are expensive because all tax payers see some benefit.

True, you don't have to spend any money for a 10% band which covers only the first 800 of taxed income. But a 2,000 band costs over 3bn and to convert the full 20% band into a 10% band costs a staggering 9bn per year.

We have seen Gordon Brown spend large amounts of money on other things, for example the NHS, education, the New Deal, Child Benefit and the Working Families Tax Credit. So if he cannot find enough even for a small 10% tax band before the election, he will lose credibility.

But that no may be no bad thing if it means that instead he devises tax policies that really improve fairness and the financial rewards of work.

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