What the budget really means for disposable incomes and incentives

Forget about what the BBC, the Government or the Tories say about the impact of the changes to personal taxation and benefits announced by Gordon Brown today. Here is what it really means for people of working age (comparing the current system with the system as it will be in 2009, according to Gordon's announcements, taking 2009 because many of the announcements are delayed or staged).

• Those earning between around £5,000 and £18,000 p.a. get to keep less of their wages than before.

• Those earning over £18,000 keep more of their wages, with the greatest benefit (proportionately) going to those being paid in the £40,000s.

• Couples with one principal wage-earner continue to pay more tax than two-income couples on the same combined household income, thanks to his rejection of any form of joint or transferrable allowance.

• The negative impact on low-earners is to be compensated mostly through increases in the threshold for withdrawal of Working Tax Credits (WTC) and, for those with children, increasing the level of Child Benefit for the first child and of the child element of the Child Tax Credit. Those with one or two children will be best-insulated by these measures from the effects of the changes to income tax. Those on low incomes with many or no children will be the worst hit.

• To avoid these increases dragging too many more people into the means-tested benefits bureaucracy, the withdrawal rate for WTC has been increased to 39%. Because losing benefits has the same impact as paying more tax on a household's net income, this has further increased the effective marginal rates of taxation on poorer households. In some cases, marginal rates of taxation are now approaching 100% - in other words, you barely keep a few pennies of every extra pound that you earn. Marginal rates of taxation determine the incentive for people to work harder, longer or smarter to earn more money, so increases in marginal rates act as a disincentive to work. Gordon announced this change as "further strengthening the incentives to work for families with children and low-income working households". The precise opposite is the case. The disingenuity of this claim marks Gordon as either a knave or a fool.

The truth is probably that Gordon cannot now abandon his reliance on ever-more generous but targeted benefits, with the accompanying means-testing, withdrawal rates and high marginal rates of taxation, without admitting he got it wrong. Gordon's problem is that more and more people are realising that his micro-managing approach is not just bureaucratic, expensive and inefficient, but downright cruel to those who would like to contribute more to their own household income but who are discouraged from doing so by the magnitude of their loss of benefits if they did. And counterproductive for the rest of us.

It is hopelessly optimistic to think that he will have an epiphany and see the error of his ways, so Gordon is relying on the poor voting tribally with Labour regardless of his penalisation of them. If people vote according to their own short-sighted self-interest at the next election, we could end up in the counter-intuitive position of Labour being the party of the rich and the Conservatives being the party of the poor. What a pity we can't have a prudent party that treats rich and poor the same.

The scale of the gains for the rich winners greatly exceeds the scale of the losses for the poor losers, though those losses may be more keenly felt than the gains will be appreciated. Given the significant increases in health and education spending, the rough balance of increases and reductions in the spending on other departments, and the reduction in the headline rate of corporation tax, this is not the balanced budget that he claimed. It is improbable that deficits and government borrowing will be as low as claimed. Allowing the public to think that times are better than they really are will result in less caution in spending and saving than would be advisable given the economic fundamentals. It all adds up to further upwards pressure on interest rates. It is very likely that what Gordon has given, the banks (and indeed the central bank) will take away. Not that Gordon cares, because he will get the credit for increasing the net household income of homeowners without taking the blame for the increases in the cost of living that result from his failure to control expenditure and balance the budget. And even if the Governor of the Bank of England has to write the dreaded letter explaining why inflation is out of control, it is very likely that Gordon will no longer be the Chancellor to whom the letter is addressed. As John Stepek of MoneyWeek puts it, it looks like Gordon is "doing a Greenspan". But will people realise it, and punish him and the Labour Party for it? Is there a credible alternative?