Note: The fourth paragraph of this observation was revised on 1st October 2013 to correct errors in the estimates of the numbers of families eligible for this tax cut. These corrections are indicated in the text.
The Prime Minister David Cameron has announced how the Government proposes to recognise some marriages and civil partnerships in the income tax system. From April 2015 it plans to make up to £1,000 of the income tax personal allowance transferable between adults who are married or in a civil partnership, so long as the higher-income adult is a basic-rate taxpayer. We estimate that this would cost the exchequer around £700 million per year. The precise cost will depend on the rate of take-up, as people will presumably have to make an active claim to HMRC to benefit, and the extent to which individuals change their behaviour in order to qualify.
The proposal would work as follows. If an individual were not using all of their income tax personal allowance – because their income was less than the allowance, which is set to be £10,230 per year when the policy is introduced – then they would be able to transfer up to £1,000 of any unused allowance to their spouse. This transferred allowance would lower the spouse’s tax bill by up to £200 a year: the amount of basic rate (20%) income tax that would be paid on £1,000. However, the transferred allowance will not be available to higher rate or additional rate taxpayers – those with taxable incomes exceeding £42,285 in 2015–16.
As the maximum gain is less than £4 per couple per week, effects on incomes and incentives (which we set out below) would be small. The social message sent by the tax break looks more significant than its financial consequences for families, as the Prime Minister has stated himself. But as a structural change to the tax system it may ultimately turn out to be more important. First, it would re-introduce an incentive to marry in the income tax system, just when Married Couples’ Allowance - now available only where one spouse was born before 6 April 1935 - had been almost entirely phased out. The benefits system affects many people’s financial incentives to cohabit (either married or unmarried) rather than live apart, mostly in the form of implicit ‘couple penalties’ (IFS researchers have quantified these here). But only the inheritance and capital gains tax systems currently affect financial incentives to marry, albeit providing big incentives to do so for the relatively wealthy. Second, the transferral of allowances between spouses would re-introduce an element of joint income taxation. This is inescapable if the aim is to assess people based on family characteristics (in this case, to target single-income families) as our benefits system already does, rather than based only on individual characteristics. There is a much wider, principled debate behind all this about the role of joint versus individual assessment.
Who would gain and who would not?
The families that would qualify for the tax break are couples in marriages or civil partnerships where one individual is a basic rate taxpayer and the other does not pay any income tax - that is,
3.4 3.9 million of the 12.4 million ( 28% 31%) couples in a marriage or civil partnership. This includes 1.2 1.4 million of the 7.8 million families with children. 2.3 2.7 million of the 3.4 3.9 million eligible families have someone in work. The rest are mostly married pensioners. The eligible families tend to be around the middle or lower-middle of the income distribution: most are in the third to sixth income decile groups. As neither two-taxpayer couples nor higher-rate taxpayers would benefit, the cash would go to families with somewhat less high incomes, on average, than under a straightforward increase in the personal allowance that cost the same amount.
Three sorts of couples in a marriage or civil partnership will not be eligible for the tax cut:
- Couples whose members both have incomes above the personal allowance.
- Couples containing a higher-rate (40%) or additional-rate (45%) income tax payer.
- Couples whose members both have incomes below the personal allowance: they would pay no income tax in the absence of the policy, so cannot benefit from any income tax cut.
Clearly then, the policy is not a general recognition of marriage in the income tax system. It is also worth noting the likelihood that take-up will be less than 100% among those eligible, as an active claim to HMRC will presumably be required.
The policy would benefit one-earner married couples but not zero- or two-earner couples, so it would increase the financial incentive to be a one-earner married couple. In particular, it would strengthen the incentive for married couples to have someone in paid work (provided that they would be a basic-rate income taxpayer), since they would pay less tax on their earnings. But married couples containing a basic-rate taxpayer would face a weaker incentive to have the second person in work (assuming that their potential earnings would take them above the personal allowance), because this would result in a reduced allowance for their working partner.
Since the transferred personal allowance would not be available to higher rate taxpayers, workers benefiting from a transferred allowance would have a weaker incentive to increase their taxable income above £42,285 (or a stronger incentive to make more pension contributions or charitable donations, which can be deductible from taxable income, to remain in the basic rate band). Indeed some could be worse off after a pay rise, or better off after a pay cut, because the transferred allowance will be withdrawn in ‘cliff-edge’ fashion – that is, withdrawn in its entirety once income rises above a threshold rather than tapered away gradually over a range of income. Income tax liability would jump by £200 per year when taxable income crossed £42,285, and hence post-tax income would be higher if taxable income were just below this threshold than if it were just above it.
One striking feature of the policy is that it complicates the income tax system. A transferable personal allowance for married couples capped at £1,000 and then withdrawn using a cliff-edge at the higher-rate threshold is not the simplest to understand. It is three years since another cliff-edge at the higher rate threshold was announced at the 2010 Conservative Party conference as a way of effectively means-testing Child Benefit, only to be removed and replaced with a less egregious taper at Budget 2012. The amounts involved here are less than in that case, which perhaps explains the willingness to cliff-edge again rather than implement a taper. Nevertheless, it is difficult to escape the conclusion that an income tax system which makes some people worse off after a pay rise has something wrong with it. Simpler ways to provide more support to working low- and middle- income married couples would include a higher work allowance for married couples in Universal Credit (with, if the government wished, a further restriction to one-earner couples).