The ‘granny tax’ or abolition of the age related allowance has immediately become a political hot potato but what is it all about? It isn’t actually a tax and it isn’t just on grannies. It is all about personal allowances.
Each year an individual’s income divides into that which is taxable and that which is not. The personal allowance then takes the first slug of taxable income out of the tax net. Usually an inflationary increase is applied to the personal allowance each year but this government made a pledge to increase the personal allowance to £10,000 over the life of the parliament, from a starting point of about £6,500.
Age allowances are enhanced personal allowances for those aged 65 or 75 and above. The 65-74 age allowance will be £10,500 for the tax year ended 5 April 2013 and the band for those aged 75 and over will be £10,660.
So to simplify personal allowances the government has decided to stop awarding them to new pensioners from 6 April 2013. For those already benefiting from age allowances the levels quoted above will be frozen until the personal allowance catches up with them. The gap between them was about £3,000 in May 2010 but narrows to just over £1,000 after 5 April this year.
Therefore there is no new tax and this is what the Chancellor meant when he said that there was no cash cost to pensioners. When an allowance is frozen, however, there is something called ‘fiscal drag’. This is a real cost; the allowance has not risen with inflation so therefore its value is less and this is what all the fuss is about.
The government may have thought the timing was good by tying it in with the personal allowance hikes but it was actually really bad timing to announce it alongside the cut in the top rate of income tax to 45%. Inevitably the headline writers would say that pensioners were financing the tax cut for the rich.
The budget numbers would suggest otherwise. £100m cost each year for the income tax reduction is only one-tenth of the £1 billion per year that will be saved by the government by abolishing the age allowances.
The £1 billion of tax cost to the exchequer of cutting corporation tax rates is actually the figure that balances this part of the budget. This measure has been almost universally welcomed by businesses.
It was also top of my budget wish list for two reasons. Firstly, from many years of observation, I firmly believe that business owners will almost always invest surplus cash to grow their own businesses. Secondly, low corporation tax rates do attract overseas investment, as it sends out a loud and clear message that Britain is open for business. The value from the growth that will be stimulated should therefore quickly outweigh the tax loss to the Exchequer. This is a government gamble that should pay off.