Exercise 3: Reforming the personal income tax for Wales

Uses:

Analyse the structure of the personal income tax in the Welsh (WL) model focusing on the personal allowance and the tax schedule

Modify the policy parameters to increase the personal tax allowance Change the tax schedule for Wales so that it matches the Scottish tax

schedule.

Description:In 2018, the UK personal income tax had a progressive schedule consisting of three bands for everybody not living in Scotland, with the highest marginal tax rate being 45% applicable to individuals earning £150000/ year. Everyone is entitled to a general deduction (personal tax allowance) which amounts to £11850/ year in 2018.

The Government has suggested that the personal income tax allowance could be increased to £12500/ year. This deduction will apply uniformly to everyone, irrespective of age or where they live. Moreover, in the near future, income tax for non-savings and non-dividends (NSND) is going to be partially devolved to Wales. You are asked to evaluate the distributional impact of this reform where Wales decides to adopt the current Scottish income tax schedule.

General guidelines:

- Identify and analyse the policy where personal income tax is implemented in WL in 2018

- Add a new system based on 2018

- Implement your reform

- Run UKMOD to produce output for both the original 2018 system and your reformed one

- Analyse the distributional impact of the reform

Additional information

Identify where the value of the personal tax allowance is set. This is done in the ConstDef_wl policy.

Identify where the values of the personal income tax bands are set. Regional code for Wales is drgn1=11

Use the same variable, constant and tax unit names for your reform as those used in the implementation of the original 2018 system

Exercise 3: Reforming the personal income tax for WalesStep-by-step solution and further information:

Step 1: Creating a new system

Our first Step is to open Wales and create a new system using the 2018 system as a base. Give the name WL_2018_Ex3 to the new system. Also, set Conditional formatting in such a way that the 2018 system is the base and hide all systems but these two - 2018 and 2018_Ex3.

Step 2: Analysing the current policyAccess the Income Tax policy in Wales (tin_wl). Consider year 2018. Hide other years (Figure 2a).Figure 2a

Analyse:► where the amount of the personal tax allowance is calculated.

► Where the tax base is calculated

► Establish where the personal tax allowance is deducted from taxable income

► Establish where the tax schedule for Wales is implemented.

Note that income concepts are defined in a common policy ilDef_wl at the top of the spine.

The structure of the personal tax allowance policy tinta_wl and the personal income tax policy tin_wl in UKMOD are illustrated in Figure 2b and Figure 2c, respectively. Further information can be found in the

Country Report (see https://www.iser.essex.ac.uk/files/projects/UKMOD/EUROMOD_country_report.pdf )

Figure 2b – Personal tax allowance is calculated by policy tinta_wl

Figure 2c – Personal income tax is calculated by policy tin_wl

Tax on Savings & Dividends (S&D)

Tax on non-savings & non-dividends (NSND)

Step 3: Implementing the reform (1 st part) From the spine, access the policy called tinta_wl (Personal tax allowance) and analyse where the amount of the personal allowance is calculated. Modify the amount of the personal allowance to deduct £12500/year for everyone (Figure 3a).

Figure 3a

Note that you could instead change the value of the constant $ITPerAll for the new system WL_2018_ex3 in the policy DefConst_wl.

Step 4: Implementing a new tax schedule for Wales (2 nd part) From the spine access the policy called tin_wl (Personal income tax) and analyse where the amount of NSND income tax is calculated for Wales.

In 2018 the tax structure in Wales is the same as anywhere else in the UK apart from Scotland. The first Elig function in Figure 4a ensures that rUK tax schedule applies in Wales.

Figure 4a

You want to introduce a reform where Wales adopts the same tax schedule as Scotland, but England and Northern Ireland maintain their original tax schedule.

Use the option copy function(s) to create a new Elig and a new SchedCalc for Wales (Figure 4b). Paste the new functions after the Scottish SchedCalc. You can copy either the rUK or the Scottish Elig/SchedCalc functions. Note that copying the rUK functions will then require more adjustment in order to adapt them for the new tax calculation for Wales.

Note: Make sure that the baseline system is not changed!!! Note that copy/pasting functions will paste anything visible. This means that you will need to clean up the baseline system after pasting the Elig and SchedCalc. Figure 4c shows how to do that.

Figure 4b – Make a copy of the Scottish Elig and SchedCalc function

Figure 4c – Set all new elements added to the baseline to n/a

Change the new Elig function so that it identifies Welsh taxpayers (Figure 4d). Remember to adjust the rUK Elig function as well.

Figure 4d – Change the Elig functions to identify Welsh’s taxpayers for the new SchedCalc, but also to exclude them from tax calculation for non-Scottish individuals

Also note that the tax band values need updating (Figure 4e). Hover over the constants storing the tax band values ($ITThresh2-5). You can see that $ITThresh4 and $ITThresh5 are still set to zero for Wales. Note that $ITThresh2 and $ITThres3 need updating too.

Figure 4e

You can either type the new values into the relevant cells in the SchedCalc or you can change value of each constant in the ConstDef_wl policy (Figure 4f).

Note: In deciding whether to change tax threshold by typing into the SchedCalc cells or changing the constants values, you need to check where the $ITThresh2-5 are used in the model and whether changing their global values would affect other parts of the tax-benefit calculation.Use Ctrl+F to search for “$ITThresh”. You will find that $ITThresh2 is used for the calculation of “transferable marriage tax allowance”. This allows spouses who do not use up all their personal tax allowance to transfer up to 10% (£1,185 in 2018) of it to their spouse or civil partner, if they earn more than them. See Country Report for more details. $ITThresh2 is used to check that the receiving partner is a basic tax rate taxpayer (higher or additional-rate taxpayers are not eligible for this allowance). This means that the partner’s taxable income (excluding personal tax allowance) should be less than $ITThresh2 (£34,500 or if they live in Scotland, £31,580).

In this exercise specific case, Wales adopts the full Scottish tax rules and you are asked to change the constants values from policy ConstDef_wl.

From ConstDef_wl, check where $ITThresh? are defined. Add two new parameters [placeholder] by clicking Ctrl+A to access function DefConst‘s “add parameter” window (Figure 4f). Note that setting column “Count” equal 2 allows adding two new lines at once into the function.

Figure 4f

Link the two new parameters to “Condition 2” by setting “Grp/No” equal 2 and fill in the relevant cells.

Figure 4g

Note that the constants names for the income tax bands in Scotland are not following the ascendant order of the tax band values. Indeed, the two new tax bands thresholds for the lower tax rates are $IThresh4 and $ITThresh5. Specifically:

$ITThresh1: threshold for starting rate for savings and dividend income

$ITThresh2: upper bound of basic rate for non-savings-non-dividend income

$ITThresh3: upper bound of higher rate for non-savings-non-dividend income

$ITThresh4: upper bound of starter rate for non-savings-non-dividend income in Scotland

$ITThresh5: upper bound of intermediate rate for non-savings-non-dividend income in Scotland.

The counter-intuitive ordering requires some attention on which value constants take and how their names are used within each SchedCalc function.

Figure 4h

Now if you go back to tin_wl and hover over the relevant constants you should see the correct amounts (Figure 4i).

Figure 4i

However, note that the SchedCalc function for Wales would overwrite the temporal variable i_tin_gross_Scotl (because of the Output_Var parameter).

Create a new intermediate variable i_tin_gross_Wls. You can do this adding a new line in the DefVar function at the beginning of the policy tin_wl (Figure 4j).

[HINT: see help for DefVar function. Use Ctrl+A to access the add parameter menu for DefVar function and select placeholder.]

Figure 4j: Add a new intermediate variable

Figure 4k: Use this new intermediate variable to store the result of the SchedCalc for Wales and add it to total gross income variable tints_s.

Step 4: Produce and analyse micro-data outputAs in previous exercises, run UKMOD using UK_2017_b1 in order to produce micro-data output for the initial and new system in Wales. Use the Statistics Presenter – option Baseline/Reform – to analyse differences in government revenues, income poverty and inequality due to the changes in the Income Tax in Wales.

Solution

Market incomes and fiscal overviewYearly, mill., currency as defined in EM output

wl_2018 amounts (base)

wl_2018_ex3 amounts

Difference to base

Total market incomes 40,043.76 40,043.76 0.00... employment and self-employment income 34,356.54 34,356.54 0.00... other sources 5,687.22 5,687.22 0.00Government revenue through taxes and National Insurance contributions 13,025.23 13,004.46 -20.76...... Personal Income Tax 5,199.78 5,179.01 -20.76Government expenditure on benefits and tax credits 10,085.84 10,083.17 -2.67... means-tested non-pension benefits 3,117.69 3,114.37 -3.31(simulated benefits) 0 0 0Working Tax Credit 152.50 152.50 0.00Child Tax Credit 577.24 577.24 0.00Income Support & Job Seekers Allowance income-based (unless simulated separately) 277.80 277.80 0.00Income-based Jobseeker's Allowance 0.00 0.00 0.00Income-related Employment Support Allowance 369.02 369.02 0.00Pension Credit 252.10 251.98 -0.12Housing Benefit 660.81 659.53 -1.29Sure Start Maternity Grant 3.54 3.54 0.00Best Start Grant (Scotland) 0.00 0.00 0.00Council Tax Reduction 273.94 273.29 -0.65Universal Credit 553.04 551.78 -1.26(-) Benefit cap (reducing Housing Benefit) 1.37 1.37 0.00(-) Benefit cap (reducing Universal Credit) 0.93 0.93 0.00... non-means-tested non-pension benefits 2,484.71 2,485.36 0.65Child Benefit 546.35 547.00 0.65

Basic Poverty Indices using a fixed poverty line

Poverty Rates for wl_2018 (base)

Poverty Rates for wl_2018_ex3

Difference to base

Poverty headcount by population group: All 14.02% 13.94% -0.08pp Children 13.48% 13.48% 0.00pp Adults 13.72% 13.59% -0.13pp Adults Economically Active 6.02% 5.93% -0.09pp Elderly 15.43% 15.43% 0.00ppPoverty Gap 17.54% 17.54% 0.00ppFixed Poverty Line 286.29 -- --

Basic Poverty Indices using a floating poverty line

Poverty Rates for wl_2018 (base)

Poverty Rates for wl_2018_ex3

Difference to base

Poverty headcount by population group: All 14.02% 14.10% 0.08pp Children 13.48% 13.85% 0.37pp Adults 13.72% 13.70% -0.02pp Adults Economically Active 6.02% 5.98% -0.05pp Elderly 15.43% 15.50% 0.07ppPoverty Gap 17.54% 17.51% -0.02ppPoverty Line 286.29 287.26 0.97

***For further information, access the UKMOD Help & Info (the last tab in the ribbon bar), click on the Help and type the word(s) in the search tab and/or you can continue with exercises.