Earlier this week I saw this tweet from Paul Lewis of BBC Radio 4’s Moneybox programme:
The 2014 rise in personal tax allowance worth £112 a year for basic rate taxpayer but £39 if on U Credit, & £195 for higher rate taxpayers.
— Paul Lewis (@paullewismoney) April 2, 2013
This struck me as odd, so I asked Paul how he calculated the £195 figure (I do not know enough about benefits and Universal Credit to make a judgement on the £39 figure). He quickly answered:
@oneexwidow >> Correctly! Checked by accountants. Using these figures hmrc.gov.uk/budget2013/tii…
— Paul Lewis (@paullewismoney) April 2, 2013
As I was busy with other things at the time, I was only able to have a brief look at the document and, initially, slightly mis-interpretted the info:
@paullewismoney Thanks! Have had look as puzzled – down to interaction of Personal Allowance rise equating to 0.6% vs. 1% increase in HRT
— Andrew Brown (@oneexwidow) April 2, 2013
The glaring mis-calculation I made was the percentage increase in the personal allowance which is of course 5.9% rather than 0.6% as I wrote! The underlying analysis however was right – the discrepancy in figures is due to the interaction between the increase to the personal allowance and the increase in the higher rate threshold.
It stuck in my mind as something worth looking into further – and worth questioning whether this met with our aims of fairer taxes.
By 2014, the personal allowance will have increased by over 54% from its level in 2010. It’s something that we’re justly proud of, and which we can be reasonably sure neither of the other two parties would have done alone (as I outlined here).
Since 2010, the threshold at which higher rate tax becomes payable has fallen to help offset the rise in the personal allowance. This has led to the basic rate limit (earnings between the personal allowance and the higher rate threshold) being squeezed from both ends, and to the upper threshold being reduced from £43,875 to £41,450.
Next year, however, the higher rate threshold will rise by 1%, and it is this rise which gives every taxpayer earning above the new limit (but less than £100,000) a tax cut of £195 as opposed to “just” £112.
So, the question: is this fair?
Now, it could be argued that £112 is worth much more to someone earning £10,000 than £195 is to someone on £41,865 or above – and this is certain to be true in the vast majority of cases. It can also be argued that reducing the higher rate threshold is, effectively, a tax on aspiration – and I am not without sympathy to this view. But at a time of austerity when we are making a big spending commitment on increasing the personal allowance, should we be providing greater benefits to higher rate taxpayers?
Although the numbers of higher rate taxpayers have increased over the years, it should be noted that the threshold at which 40% becomes payable (£41,865) is still some way above the median gross income (£26,500).
It may not be the stuff of popular campaigning, but perhaps we should be pushing behind the scenes for the higher rate threshold to be frozen. In the future, we should consider how we manage tax bands so that they remain progressive whilst minimising such anomalies.
* Andrew Brown is a Deputy Leader of the Lib Dem Group on Bristol City Council, and was parliamentary candidate for Bristol South in 2019.
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13 Comments
It’s not sustainable to keep reducing the higher rate threshold and increasing the personal allowance. Over time the higher rate threshold will have to go up as well, or else we’d end up scrapping the principle of progressive taxation of income.
It perhaps shouldn’t be the priority, but it’s not something which we can credibly oppose, especially factoring in inflation. Creating more higher rate taxpayers isn’t an achievement unless it’s because more people are better off.
Increasing the tax thresholds by the rate of inflation is effectively a tax freeze, as wages follow inflation in the long term. Increasing them by more than inflation is a tax cut, by less than inflation is a tax rise. The rise in the HRT is below inflation and is thus effectively a tax rise. Indeed, some argue that the thresholds should be linked to inflation specifically for this reason.
The common failure of the thresholds of tax bands and allowances to keep up with inflation is known as “Fiscal drag” and is a “stealth” source of extra tax income for the Govt of the day.
I don’t think Paul Lewis is right to say that. Increasing the higher rate threshold here is a separate matter from increasing the personal allowance, and the 1% increase shouldn’t in the former shouldn’t be considered part of the latter. Secondly, it’s the ‘real’ level that’s important and a 1% increase is of course less than inflation. Finally, what’s happening this year should be considered in conjunction with what’s already happened: as you say, the higher rate threshold has been cut in absolute terms and cut significantly in real terms. As I keep saying, we need to do more to target these tax cuts on poorer households (the vast majority of the cost goes to the top 50%), but it’s not true to say that higher rate payers are (as individuals) benefiting more.
The Universal Credit point is actually much more important: 65% of this tax cut will be withdrawn from households on UC, and that’s not a minor issue – we’re talking about perhaps the poorest 30% of households, the very ones that the party presumably likes to think we’re helping (and that’s even if they’re in work and earning enough to benefit).
Thanks for comments so far.
@Stuart Wheatcroft: Agreed – it’s not sustainable to keep freezing the Higher Rate Threshold, but I wanted to engender debate as to whether now was the time to start increasing it again.
@MBoy: Agree with the general point, and personally believe that we need to better codify the tax bandings in future – whether that be all allowances/thresholds rising by the same monetary amount or fixed/inflation-linked annual rise. But in this case, the Personal Allowance is rising by over twice the rate of CPI, and freezing the Higher Rate Threshold would not stop Higher Rate Taxpayers from benefiting.
@Adam Corlett: I accept that the Universal Credit is probably much more important – unfortunately I don’t know enough about the detail to comment!
On the issue of fairness, higher-rate payers may feel a little aggrieved if they didn’t get a little something back after having the bands lowered to pay for a big income tax cut to lower income earners – even if they might agree they shouldn’t get as much. (Then there’s the effect of inflation as already mentioned by Stuart and MBoy.) Of course, if I understand correctly, if you take 2009/2010 as the base then low income and basic rate payers have had a bigger increase overall than higher-rate payers.
How about linking income tax-bandings to the minimum wage, with the higher rate limit starting when someone earns above a multiple of the minimum wage? For example, 4 x MW = £50,510, not far off from the current banding.
The Personal Allowance should, naturally, be tied to the Minimum Wage, for which in turn we could introduce something similar to the state pension’s “Triple Lock” – maybe using the *median* rather than the highest of inflation, 2.5% or earnings to prevent circular increases where increases in earnings drives up the rate increases in earnings, etc. As the minimum wage increases so does the upper limit… ah, which increases 4x the increase in MW. Hmmn… of course that doesn’t mean basic/higher rate people’s wages increase automatically.
But what about any loss of Govt income? Well, I think income tax is over used and overrated and we should be countering any loss through wealth taxes. ~50% of the population earns less than double the MW, while the top 5% earners posses 60% of the nation’s asset wealth (source: ALTER)
(Oops, I misread the current limit. I should have used 3 as the multiple (giving £37,823) instead of 4.)
I would endorse the comments of Mboy in noting that “The common failure of the thresholds of tax bands and allowances to keep up with inflation is known as “Fiscal drag” and is a “stealth” source of extra tax income for the Govt of the day.”
The recent above inflation increases in the personal allowance have gone some way to correcting the earlier failures of the Labour government to increase pesonal allowances in line with cumulative inflation.
The key issue here, in my opinion, is the failure to recognise or mitigate the interaction of tax reductions and benefit withdrawals on those with income below the minimum wage. A £700 tax cut is a very significant boost for mimium wage earners. However, if 65% of the cash benefit is lost by benefit clawback and the rest and more is absorbed by council tax benefit withdrawal , VAT increases and fuel and food inflation then nothing tangible has actually been put in the pocket of the lowest income earners.
The distributional impact of budget changes, set-out in the red book, make it clear that proportionally the weight of tax and welfare changes fall heaviest on the top and bottom income deciles.
It is perhaps here that Libdem ministers have been blinkered in pursuing the flagship policy of increasing the personal allowance to £10k at all costs, while paying insufficient attention to the distributional impact of welfare changes on the lowest income earners.
My view remains that a basic income equivalent to the combined rate of basic income tax and employee national insurance should replace the personal allowance and be paid by way of the tax credit/Universal credit system. Coupled with a minimum wage job guarantee scheme we would be a long way down the road to providing real and efective support where it is most needed and eliminating the kind of anomalies that we continually see from annual tinkering with the current tax and welfare sysytem.
Fairer taxes? Attempting to modify the income tax bands is a reasonable pursuit, to tweak fairness, but when speaking of fairer taxes in general, it doesn’t address the tax avoidance, at the upper end of the corporate food chain. I accept that the following, is a bit of blue sky thinking, that would benefit from someone with a better understanding of tax issues.? But, what if.?
The government appears to be at a loss to get the Amazons and Starbuck types, to pay the taxes they are due, because of clever off shoring manoeuvres. But one thing that these corporations can’t really mess around with is VAT. When it comes to VAT, to all intents and purposes companies are just ‘middle men’ tax collectors. They take 20% from the customer and pay 20% to HMRC.
But what if, the VAT tax rate was made different between (customer ~ company), and (company ~ HMRC), dependent upon the size of company, and location of headquarters? Suppose (for example), the VAT rate was dropped to 18% for the customer, but for a company, not headquartered in the UK, then HMRC were still to collect VAT from the company at 20%. Would this not be a better way to collect taxes from those large off shored corporations?
So whilst the customer would pay 18% VAT :
~ A VAT rated, SME, would be expected to forward 18% VAT, to HMRC
~ Larger companies based in UK, with (say > 2000 employees), would be expected to forward 19% VAT to HMRC
~ The offshored Starbucks, Amazons etc, would be expected to forward 20% VAT to HMRC.
Would such a tax modification be possible, and are there downsides to such a proposal?
When looking at fairness in taxation, it is always wrong to analyse one specific aspect in detail, without looking at all the parallel changes that are taking place. That is, of course, what all governments want you to do. The simplest way to seek popularity in tax policy is to give with hand A, take away with hand B, shine a spotlight on hand A and hide hand B behind your back.
Sometimes this approach is “successful” for governments. Sometimes it gets rumbled. Unfortunately, it is what the Lib Dems have done by pointing to their flagship “achievements” on tax thresholds, while keeping quiet about all the bad things like rising VAT and falling benefits that are also going on. The reason that a grateful nation is able to curb its enthusiastic applause for these achievements is quite simple – we don’t really deserve it.
Stephen Tall ran a piece a while back, I recall, which did the right kind of analysis. It looked at all the tax changes together. That showed that the rich (apart from the very top 10%) were gaining by comparison with the poor.
Gordon Brown’s ceaseless tinkering with the detail has left our tax system awash with anomalies. Another is that whilst the marginal tax rate for the oft-mentioned millionaires is 45% (plus NI), the marginal rate for people earning between 100,000 and soon 120,000 is much higher at 60%. This arises from Brown’s wheeze of phasing out the personal allowance across these incomes. Of course people at that level are earning a decent wage, but there is no justification for their marginal rate being so out of line with the real ‘millionaires’?
Are the real ‘ millionaires’ people who now own a million or more or people who earn a million or more in a year? As always, people confuse wealth with income, and vice versa.
What Ian said about the effective 60% rate for those earning just over £100K . Progressive my ‘****.
With all this talk of marginal tax rates, lets not forget who has the highest marginal tax rates of all:
No its not higher rate tax payers on 40% (plus 2% NI)
its not those earning over £100,000, with a marginal rate of 60% for a small fraction of their earnings.
Is it top rate taxpayers, who earn over £150,000 each year? No theyve had a tax cut to 45% (plus 2% NI)
Is it graduates on the average wage, facing a rate of 20%, plus 12 % NI (yes twelve) PLUS 9% graduate tax (a total of 41%!)
No its people struggling to get over the poverty line, who will face a marginal tax rate of 65% on the universal credit. This 65% rate will apply to every penny of their earnings, not just a few pounds over £100,000.