A comprehensive analysis of whether tax and marriage really do go together 'like a horse and carriage...'
The Tory party has now announced their long-awaited plans how they want to
recognise marriage in the tax system. There will be a partially transferable tax allowance for married couples and those in civil partnerships only, where one partner is earning up to £44,000. David Cameron said that “that commitment is a core value of a responsible society, and that's why we will recognise marriage”. The week before
the Sunday Times quotes a Senior Tory source saying “The aim is to reward and incentivise marriage and help couples at a time when they most need it.” What time is this? Surely, the time with the broken nights, with the loss of income, with the tiredness, i.e. when a couple just had a baby! But now, a couple of days later, no word on children, it is the commitment to the other partner that counts.
I do think any ‘marriage recognition' should be reserved for couples with children as couples without children do not face the broken nights, loss of income due to a baby, etc. Plus, if a couple (married or not) breaks up before they have children, that is probably a good thing! At least it is better than breaking up after they have had children. If the marriage recognition applies to a limited time only, let's say for twelve months after the child is born it could be applied again for a year for any subsequent children.
But back to basics first. One might like to think that decisions such as getting married or having children are private matters free of state influence. But most people would admit that money, and especially the lack of it, plays a strong role in these matters. Although this is unlikely to be the only reason, if the tax system becomes more beneficial to the one-earner marriage, there will be more people getting married and following a traditional family set-up (as can be seen in Germany, for example). If tax benefits are increased for single parents, then the society will see higher numbers of those (as can be seen in the UK).
The introduction of the individual taxation in 1990, the abolition of the Married Couples Allowance and the rise of benefits for single parents has certainly had an impact on people's choices and definition of a family. The current Labour Party's credo to support “hardworking families” tries hard not to distinguish between different family set-ups. The Conservative Party plans to strengthen the traditional family set-up and to end the ‘couple penalty' and recognise marriage in the tax and benefit system as they see family breakdown as the cause of a series of social and economic problems.
What are the options in general to recognise marriage in the tax system? There is joint taxation, i.e. income splitting; a transferable tax allowance for married couples (as suggested by Iain Duncan Smith MP) or simply a higher tax allowance for those individuals who happen to be married. Let's look at the first: income splitting. This is most successful – I mean effective – in a system with a progressive tax rate as is the case in Germany and France.
In Germany, the constitutional law protects marriage and family which the tax law translates into the joint taxation of married couples, regardless of any children. Married partners can choose to be taxed individually or decide to pool their incomes and apply the so-called income splitting. The couple's joint income is divided by two and the corresponding tax rate (progressive under the German tax system) is applied to each of the two equal income shares. Given the progressive tax rate, the total tax take under income splitting is lower than the tax take which otherwise would have been paid on the two individual incomes. The implication is that the highest ‘gain' (or tax savings) can be made if one partner has substantial earnings and the other partner earns very little, if anything. This is widely seen as a problem and as a strong argument against income splitting since it deters mothers to (re)join the labour market after having had some time off to look after the children. But the strong argument for the income splitting is that married couples with equal aggregate income are treated equally from a tax perspective, despite different individual incomes of the married partners.
France is well known for its long tradition of a pro-natalist family policy with generous family allowances, a strong support for working mothers and a tax system that rewards having children. As in Germany, the family is seen as a household unit and is therefore taxable as such. For tax purposes, the household income is added up and then divided by a divisor based on the size of the family. For married couples without children this takes the same form as the income splitting in Germany, with the pooled income divided by two. However, when children come into play the divisor is increased by 0.5 for the first and second child and by 1 for the third child. The tax formula is then applied to the resulting income shares of the two adults. By calculating the tax burden in this way, children are acknowledged as dependants and the family receives a tax relief. As a result, parents on average income who have at least three children de facto do not pay tax. Thus, in France having children rather than marriage is rewarded by the tax system, especially as the ‘family splitting' applies to married as well as unmarried couples who have signed a civil partnership.
The taxation of families in France and Germany is markedly different from the current UK system where the wife, the husband and the children are seen as independent individuals for tax purposes. While our tax system is geared towards the individual rather than the family with the underlying idea to remain on neutral ground, France has a taxation system which supports a pro-natalist policy, whereas Germany's family taxation is modelled on the traditional ideal of a family with married parents.
In the UK a universal introduction of joint taxation combined with income splitting however would not be sensible. Income splitting works best if partners are taxed with different tax rates. As about 88 percent of the working population pays the basic tax rate, only those relatively few couples, where one partner is a higher tax payer and the other a basic tax rate payer, and – by applying income splitting – the higher rate tax payer would become a lower rate tax payer - would benefit. This is most likely to be the middle-class couple where the husband works full-time and the wife part-time so she has more time with the children. These are not really the couples who need financial support.
But – and that's a big but – income splitting can be very advantageous for those couples where one partner earns less than the individual tax allowance of £6,475. An example: one spouse earns £4000 per year, the other spouse £12,475. The first pays no tax at all, the second pays tax on £12,475-£6,475=£6,000. At the basic tax rate of 20 percent this is a tax bill of £1,200. Now, let's apply income splitting. The combined income of the couple if £16,475. Divided by two this is £8,237.50. So each spouse is allocated (for tax purposes) an income of this amount. For tax calculation the personal tax allowance is deducted: tax of 20 percent is paid on £8,237.50 - £6,475 = £1,762.50; the tax take is £352.50 each. Multiplied by two, this is £705, considerably lower than the tax bill of £1,200 in case joint income splitting is not applied. So maybe income splitting should be restricted to those married couples on very low income?
But even if an universal introduction of income splitting might not be suitable for the UK tax system a lesson can be learned from the German and French examples. In those countries (married) couples with children are seen as an unit, not as individuals being thrown together by accident. Joint taxation makes sense insofar as it is not difficult to argue that in fact family members are financially dependent on each other, for example, through sharing a mortgage and the costs of everyday living. This dependency is certainly even more pronounced when children are involved. And with economic and social problems that children of lone parents are more likely to face, it can be argued that couples staying together and raising children together should be rewarded within the tax system.
This leads to the second option: the transferable tax allowance. According to last week's article mentioned above it looked like that the idea of a transferable tax allowance is not going to happen as this would be (shock, horror) “a subsidy for stay-at-home mothers”. The Tories are looking for a silver bullet that “would equally reward working and non-working mothers”. What is wrong with a subsidy for stay-at-home mothers? Nothing I think; provided it is not unlimited. The majority of mothers does stay at home for at least six months, so why not give the happy couples a (tax) break during this time?
Again, this could be applied to basic tax payers only to recognise that those on lower incomes are less likely to get married than those on higher income and give them a bit of extra incentive and help.
The third option is simply to increase the individual tax allowance once someone is married, so let's say instead of the current £6.475 it could be £7.200 or so. That would certainly recognise marriage and also help those on very low incomes but keeping in line with individual taxation at the same time. I am not in favour of that one as any amount would seem rather random and just being married doesn't mean you are a better person who needs a financial reward.
All three options could have a dynamic element. For example, it can be applicable only to married couples in the first year of each child's live. It could be applied for the first year of a marriage (if children are involved), and could subsequently applied for the fourth year, the eights year and so on to reward long-term stability of a relationship. Another possibility to reward long-term stability could be to increase the marriage tax allowance in line with the length of the marriage, maybe flatting out by the time the children come of age. Endless possibilities, it seems!
The Tories decided to go for a down-sized version of the second option. Financial constraints obviously do play a role when deciding the size of the transferable allowance. However, they still seem uncertain what they want to recognise: marriage per se or commitment or having children within a stable relationship or making sure the mother can stay at home for a bit? This is still not clear.
Recognising the family as a unit and not as a bunch of individuals happen to live together might be the starting point to come up with a (better) solution of how to recognise marriage in the tax system.