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Clause 4 - Indexation of limits and allowances under ITA 2007

Finance (No. 2) Bill – in a Public Bill Committee at 3:45 pm on 29th April 2014.

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Photo of Shabana Mahmood Shabana Mahmood Shadow Minister (Treasury) 3:45 pm, 29th April 2014

I beg to move amendment 3, in clause 4, page 3, line 25, at end insert—

‘( ) The Chancellor of the Exchequer shall, within three months of the passing of this Act, undertake a review of the expected impact until 2020, of changes to indexation limits and allowances on—

(a) the numbers of those not paying income tax in 2014 who begin to be eligible for basic rate income tax over that period;

(b) the numbers of basic rate income tax payers in 2014 who begin to be eligible for the higher rate over that period;

(c) the overall receipts from those paying income tax over the period broken down—

(i) for the average UK household;

(ii) for the average single-earner UK household with two children;

(iii) for the average UK household with two earners and two children;

(iv) for the average single person.’.

Photo of Gary Streeter Gary Streeter Conservative, South West Devon

With this it will be convenient to discuss clause stand part.

Photo of Shabana Mahmood Shabana Mahmood Shadow Minister (Treasury)

Clause 4 changes the basis for automatic indexation of tax allowances and limits, such as the personal allowance and the basic rate limit. It means that from 2015-16, any automatic increase in those allowances and limits will be made by reference to changes in the consumer prices index rather than the retail prices index. The change is measured over 12 months to the September before the relevant tax year. The automatic indexation can be overridden, as it has been, for example, in 2014-15, when the personal allowance was set at £10,000 and the basic rate limit was decreased.

Amendment 3, again, seeks a review into the impact of the changes to the indexation limits and sets out some of the things that should be assessed for the impact that the change will have, including the number of people not paying income tax in 2014 but who will be eligible for basic rate income tax over that period; the number of basic rate payers who begin to be eligible for the higher rate over the same period; and the overall impact that the change in indexation has and the overall receipts from those paying income tax—again broken to down to help to illuminate debate in this area—for the average UK household, single earners with children, the average UK household with two adults and two children, and for the average single person as well.

This change from the RPI to the CPI measure of inflation is not new for a Finance Bill Committee. It has been discussed in previous Finance Bill Committees and by Work and Pensions Ministers and shadow Ministers in relation to Bills connected to welfare and pensions uprating. This issue has been debated at length by hon. Members ever since the first set of changes to indexation were made by the Government with this move from the retail prices index to the CPI measure of inflation. The change is significant. The thrust of our amendment 3 is to get some additional analysis of the impact of that change on indexation. Some have labelled it a stealth tax and there has been a lot of debate about it previously in this Parliament. It is important that we understand exactly what the impact of the change from RPI to CPI has been.

Both RPI and CPI measure inflation by taking a basket of goods—food, clothes and petrol—looking at what they cost last year, what they cost now and finding the proportional difference. The CPI differs from the RPI because it leaves housing costs out of the basket of goods that it measures, so rises in mortgage payments, rents and council tax are not reflected within the CPI measure of inflation. The retail prices index, however, takes those housing costs into account. So there is a difference between the two in terms of what they measure and what is in the basket of goods that gives the overall calculation for the value of both those indexes.

There is also a mathematical difference in the way the retail prices index and the consumer prices index are calculated. The RPI calculates what is called the proportional difference, using the arithmetical mean between the old price and the new. The CPI does not use the arithmetical mean but the geometric mean, which gives a different set of figures. That mathematical difference between calculating the RPI and CPI means that the RPI almost always gives a bigger figure for inflation. Each year, the RPI rises on average by 1.2 percentage points more than the CPI.

There is a whole set of issues around the differences between the two measures and around which best and most accurately reflects inflationary pressures when we look at uprating benefits and, as envisaged in clause 4, the indexation of limits and allowances under the Income Tax Act 2007. Using the consumer prices index means that allowances and tax rate limits would increase at a lower rate than under the retail prices index, therefore raising greater revenues. The effect of that change over a much longer period could be very significant, given the compounded nature of the change. The reason why that has been an issue of debate throughout this Parliament is because of the significance of that change, the fact that it is compounded over time and the big difference between the numbers that result from indexing according to RPI and those that result from indexing according to CPI. That has a large impact on Government revenues, which in turn has an impact on individuals either through limits in allowances and taxation, or through benefits that they miss out on. The amendment is designed to try to get better analysis about the impact of the changes and what they will mean for different rate payers in our current taxation system.

In this place, there is a lot of debate around RPI and CPI, and we bandy those measures about in the Westminster village, in the conversations we have with journalists and in the interviews that we give. However, I do not think that they are well understood by ordinary members of the public. I sometimes think that the terms that we use in this place as part of our normal discourse, when we talk about indexation, uprating and so on, must seem impenetrable to ordinary people. Those people are significantly affected by the changes, but they do not necessarily understand from our discourse here in Westminster what is going on or why certain choices have been made. For that reason, despite the fact that the move from RPI to CPI has been discussed several times in previous debates, we must continue to press the Government on that point.

Clause 4 changes things in relation to taxation. Previous debates have been about pensions and benefits uprating, but broadly the same sorts of issues apply. In the public debate that we have with ordinary people who are drawn into different tax brackets because of the difference between indexation under RPI and indexation under CPI, we must be better able to explain exactly why the changes are being made and what their real impact will be. That could illuminate debate well into the next Parliament.

When the Government made the change from using RPI to using CPI in the uprating of benefits at the beginning of the Parliament, there was a suggestion that they would look at the change again if a significant case was made and the arguments were strong enough. We will not know whether a significant case has been made or whether the arguments are strong enough to consider indexing differently without better analysis of the impact of the change. It would be helpful, through a review such as we propose in the amendment, to see the impact of the change on basic rate taxpayers, to see who gets drawn in, and on higher rate taxpayers.

We do not intend to vote against clause 4, but we will press the amendment to a vote because we think that the matter requires greater analysis and greater public debate. It is important to shine a stronger light on what the change means. Many people have described it as a  stealth tax. As we discussed earlier, there will be significant changes in the implementation of taxation, and it is important that they do not seem impenetrable or out of reach for ordinary members of the public. They have the right to understand exactly what the changes mean and what impact they will have on them. The change will have a significant impact on the Government’s revenue, and that of course is the reason for the change. It should be spelled out clearly to the public who will end up paying more. We will support clause 4, but we will probably press amendment 3.

Photo of David Gauke David Gauke The Exchequer Secretary 4:00 pm, 29th April 2014

Clause 4 makes changes to the indexation basis for income tax allowances and limits, and it may be helpful if I set out a little of the background. It was announced in the 2011 Budget that, in response to an independent review by the Office for National Statistics, CPI inflation will be the standard indexation assumption for direct taxes from 2012. However, it was also announced in that Budget that all RPI-indexed income tax thresholds would move to CPI indexation in later years, and that the personal allowance would move to CPI indexation after reaching £10,000.

For simplicity, we decided to deal with all income tax indexation changes in a single piece of legislation. Income tax thresholds closely connected to the personal allowance are the basic rate limit and the higher rate threshold. The basic rate limit sets the width of the 20% basic rate tax band above the personal allowance. The higher rate threshold determines the starting point of the 40% higher rate tax band, and is the sum of the personal allowance and the basic rate limit.

The announcement in the 2013 Budget on the personal allowance meant that it would move to CPI indexation in 2015-16. To ensure that the income tax system remains consistent, we decided that the indexation of the basic rate limit should move to CPI indexation at the same time as the personal allowance. That ensures that the higher rate threshold will also grow in line with CPI inflation in the absence of policy changes. Clause 4 implements that switch.

Clause 2, which we debated earlier, sets the personal allowance and basic rate limit for 2015-16, and means that the Government will override CPI indexation for the personal allowance and the basic rate limit in 2015-16 in line with the Chancellor’s announcements at last month’s Budget.

The remaining RPI-indexed income tax allowances and limits, including the adjusted net income limit, married couples allowance and blind persons allowance, will be increased in line with RPI inflation in 2015-16 by overriding the annual indexation order for that year. That will ensure that no one will be worse off as a result of changes to indexation in this Finance Bill compared with our previous plans.

Amendment 3, tabled by Opposition Members, would require the Government to carry out a review, projected to 2020, of the impact of moving to CPI on the number of basic rate taxpayers, higher rate taxpayers and certain types of households. The purpose of the amendment is, as we have heard, to compare the changes to income tax personal allowances and rate limits under RPI and CPI indexation. The amendment essentially misses the point. We are moving to CPI for three reasons. First, it is calculated using a formula that better reflects the way  people shop around in response to a change in price. Secondly, it forms the basis of the Bank of England’s inflation target. Thirdly, it is more consistent with the European Central Bank’s harmonised index of consumer prices than RPI. In March 2013, the UK Statistics Authority, following a review, judged that

“the methods used to produce the RPI are not consistent with internationally recognised best practice”.

On that basis, I do not believe that the amendment could achieve anything useful, and I ask the hon. Member for Birmingham, Ladywood to withdraw it.

I am grateful for the hon. Lady’s support for clause 4, which helps the Government to achieve their aim of a tax system that is fair and easy to understand. I hope that amendment 3 will be withdrawn and that clause 4 stands part of the Bill.

Photo of Shabana Mahmood Shabana Mahmood Shadow Minister (Treasury) 4:15 pm, 29th April 2014

I am grateful for the Minister’s comments on clause 4 and the amendment. I am minded to press the amendment to a Division. It is very important. I take on board what the Minister has said, but the change from the RPI measure of inflation to CPI for indexation of taxation limits and allowances is significant. Regardless of where one sits in relation to whether that is a good or bad thing, it is worth having the review so that we can assess the impact of the change and more thoroughly ventilate those issues in public debate.

Question put, That the amendment be made.

The Committee divided: Ayes 13, Noes 14.

Division number 2 Decision Time — Clause 4 - Indexation of limits and allowances under ITA 2007

Aye: 13 MPs

No: 14 MPs

Ayes: A-Z by last name

Nos: A-Z by last name

Question accordingly negatived.

Clause 4 ordered to stand part of the Bill.