To keep the cost down, the increase of £1,000 in the personal allowance this year excluded higher rate taxpayers and over 65’s. Also, the higher rate threshold was reduced to bring more people and income into the 40% tax band.
The 2011 budget announced an increase in the personal allowance for under 65’s by £630 in April 2012, with the higher rate threshold unchanged. The freezing of the higher rate threshold brings more people and a greater proportion of existing earnings into the higher rate band – so-called fiscal drag.
This process seems consistent with the aim of increasing the personal allowance and ensuring that the benefits are targeted at low and middle-income families.
However, from 2012, middle-income families being drawn into the higher-rate band as a consequence of earnings growth may find themselves not only paying a higher proportion of tax on the their income but losing child benefit as well – £1752 for a two child family.
As the final touches to the 2012 budget are put in place, we might consider the following:
Increasing the personal allowance to £10k now can alleviate the loss of income that median income families face, as the income thresholds and income disregard levels for working tax credit and child tax credits are reduced.
Higher income taxpayers should not be excluded for two reasons
- If a higher rate taxpayer can see a tax reduction of £760 and the higher-rate starting threshold is increased to £45,000. It will ease the concerns over the impact of withdrawing child benefit from taxpayers starting to earn a little over the current higher rate threshold of £42,475 in the next three years.
- An increase of this level in the personal allowance will need to be paid for, most likely, by limiting tax relief on pension deductions to the basic rate of 20%. The tax that could be generated from this measure is estimated at over £7 billion; more than 2.5 times the cost of giving higher-rate taxpayers the benefit of the increased allowance.
Giving 21 million basic rate taxpayers (earning over £8105) a tax reduction of £380 a year will cost approximately £8 billion this year. The cost of including an extra 3.5 million higher-rate taxpayers (earning below £100k) is about £2.6 billion. The extra costs (after fiscal drag) over and above expected future increases in the allowance would be about £7 billon in year 2 and £3.5 billion in year 3.
How will it be paid for? The estimated 7 billion per year that would be generated from cpping pension relief at the basic 20% rate would make the measure revenue neutral over the remainder of this parliament.
Contributions to personal pension plans by higher rate taxpayers would continue to be topped up by the equivalent of basic rate tax, as they are now. Consequently, the measure does not directly reduce the level of savings going into pension plans. There could, however, be a reduction in pension savings, if higher earners seek to offset higher taxes by reducing their net contributions.
* Joe Bourke is an accountant and university lecturer, Chair of ALTER, and Chair of Hounslow Liberal Democrats.
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22 Comments
Is £43,000 a “middle income” now?
Whatever happened to “there is no money”? This might be all very well if it weren’t for the fact that spending on public services is being severely cut because we are supposedly in the middle of a fiscal crisis.
Surely politics is a question of priorities, and tax cuts for millionaires seems a very strange one – at least for a Liberal Democrat – in the present situation!
I don’t understand where tax cuts for millionaires comes from? The priority is taking the poor out of taxation and reducing the tax burden on the middle.
Is £43k a middle income? Yeah, it’s reasonably middle… The average family income in the UK is £32k so it’s not that much higher, only about £7.5k after tax.
If the Tories would listen and introduce the mansion tax and reduce tax relief for big pensions then they could probably afford to get rid of 50%, increase the allowance to £10k and also keep child benefits for those on 40% tax.
The reason the Lib Dems aren’t overly fussed about the 50% rate is that it doesn’t really work. Yes, it takes a reasonable amount off those better paid like GPs or owners of small businesses but anyone who is a millionaire will not pay it. A lot of them already made their money years ago or will simply give up their jobs and instead set up overseas companies in countries with less tax and get their employers to take services from them. There is no way of stopping this unless we stop blocking trade with various overseas countries who charge less than 50% tax and that would be ridiculous.
@Joe: I utterly agree, but I’m surprised that – as an accountant – you’ve not mentioned the worse aspect of the personal allowance claw-back, which is that, at certain points in the income range, it leads to phenomenally high marginal tax rates. For example, a person earning £100,000 pays (from memory) 62% tax.
Now I know that Chris and others will argue that “politics is a question of priorities” and that “tax cuts” for people earning over £100,000 should not be among them, but I would counter that with two points:
1) The tax should never have been raised to that level in the first place. Clawing back the personal allowance with a particularly nasty little tax rise because it did away with the basic principle that everybody can earn their first £7,445 tax free. That principle should have been protected and should now be restored.
2) Nobody should be paying a marginal rate of 62%. Ever! To quote Vince Cable:
“two rather simple guiding principles should apply. The first is that the state – national government – should not take more than, say, 40% of GDP in tax… The second is that the marginal rates of direct tax should not exceed 50% at any point in the income range.”
If only he practised what he preached.
(In the interests of full disclosure, I should point out that I do not earn £100,000 or anything near it.)
It’s the non-tapered child benefit withdrawal that’s the problem; not lowering the higher rate threshold.
It’s absurd to suggest higher-rate taxpayers should be given a tax cut at the moment.
If your sole family income is £40,000 in London with two+ kids you are in no way rich.
Chris,
On the assumption that the personall allowance and higher rate tax threshold is frozen for the remainder of this parliament, the measure is revenue neutral over three years i.e. there is no cost to the exchequer. The increase is paid for by clawing back higher tax relief on pension contributions made by higher earners.
Millonaires and those earning over £120,000 do not get a personal allowance and would pay substantially more tax as a consequence of the pension relief restriction.
In terms of priorities, I don’t disagree. Given the choice, I would plow the money into a job guarantee scheme.
Job guarantees . However, I suspect that this is not on the cards for next week’s budget, but rather a policy to be pursued, if we don’t see a turnaround in the direction of unemployment over the next few months.
Increasing the personall allowance can mitigate the steep drop in purchasing powerand demand that inflation, benefit cuts and pay freezes are having in the current economic climate and at least not make our situation substantially substantially worse than at present.
Tom,
as you note Vince Cable states the case quite succintly – “two rather simple guiding principles should apply. The first is that the state – national government – should not take more than, say, 40% of GDP in tax… The second is that the marginal rates of direct tax should not exceed 50% at any point in the income range.”
Another area where the marginal tax effect, that you note, occurs is with the reduction of the age related allowance for over 65’s with income over 24k and over 75’s with income over £29k.
I would like to see a rationalisation of our whole tax and benefit code to modify these cliff-edge anomalies in line with the principles Vince Cable has enunciated.
Tommy,
When I first started practising as an accountant in the mid-seventies the highest rate of tax on earnings was 83% and there was a 15% investment income surcharge on top, giving an effective rate of 98% on the dividends and investment income of higher earners.. The basic rate of tax was also 33%. The punitive tax rates were as much a cause of the fall of the Callaghan government as was the 1978/79 winter of discontent.
It was during this period of time that legal tax avoidance schemes and offshore residence exploded from what had been a niche area for the super-wealthy to the mass-market industry it has become today.
It is this experience that makes me uncomfotable with high rates of tax on income and, like you, I would be perfectly comfotable with a policy that replaced the 50% higher rate with a more effective mansion or wealth tax.
Adam,
“It’s absurd to suggest higher-rate taxpayers should be given a tax cut at the moment.” – They won’t be. An example may be the best way to illustrate:
Married man, sole earner with two childrem
2011/12 Earnings £50,000
Pension contributions £4,000 (£5000 gross inclusive of basic rate credit)
Taxable Income £45,000
Personal Allowance £7475
Tac payable:
35000 @ 20%
Adam,
The tax payable in 2011/12 is:
35000 @ 20% – £7000
2525 @ 40% – £1010
————-
£8010
Less – Pension relief (1000)
————-
Tax paid £7010
Less: Child Benefit (1752)
Adam,
The tax paid in 2011/12 was £7010 and child benefit is £1752 i.e a net contribution of £5258.
2012/13 Earnings £50,000
Pension contributions £4,000 (£5000 gross inclusive of basic rate credit)
Taxable Income £45,000
Personal Allowance £10,000
Tax payable:
35000 @ 20% – £7000
The tax paid in 2012/13 is £7000 compared with £7010 in the prior year, The net contribution in 2012/13 is £7000 compared to £5258 in the prior year i.e an increase if £1742.
Sorry for the split posts. I keep hitting the return key at the wrong tims.
“It’s the non-tapered child benefit withdrawal that’s the problem; not lowering the higher rate threshold.”
That is the problem, but as a party we are committed to increasing the personal allowance to £10k as soon as possible. Creating ever more higher-rate taxpayers at the margins while at the same time withdrawing child benefit from median income households is counter-productive.
In the seventies, higher-rate taxpayers made up about 3% of the taxpayers, it is now 15% – a five fold increase in a single generation. At this rate of growth, the majority of taxpayers will be in higher-rate bands within another generation. What will we do then?
I favour Beveridge’s original concerption of a universal child benefit over means testing. However, If it is to be withdrawn – amalgamation with the child tax credit system might provide a more balanced approach.
Err, £45k = median national income x2… “tax cuts for millionaires” this is not.
This is tax cuts for everybody, and which impact must be taken into consideration with other reforms (ie like child benefit), to make the tax and welfare system better tailored according to ability and need (at least that’s the idea).
However, raising the tax threshold to £10k is a flimsy if expedient round number. It itself is a compromise with the liberal principle to raise allowances to the level of full-time work at minimum wage (currently about £11.8k).
And didn’t Danny Alexander recently state his intention to raise the threshold to £12.5k, thereby bringing tax allowances into line with the minimum wage when this is raised?
“In terms of priorities, I don’t disagree. Given the choice, I would plow the money into a job guarantee scheme.”
I’m baffled. You’ve written an article entitled “Let’s raise tax threshold for all taxpayers”, but you say you’d rather put the money into a job guarantee scheme.
Shouldn’t the article have been entitled “Let’s introduce a job guarantee scheme”?
@Joe Bourke: Yet another area is in the combination of taxes and benefit withdrawal for people earning in the high thousands but below £10,000. I think the withdrawal rate (which is in effect the same as the marginal tax rate) is something like 74%.
“Work should always pay….. but it shouldn’t pay very much”!
Don’t forget to sign the petition to fast track the £10,000 income tax threshold rise http://epetitions.direct.gov.uk/petitions/28640
Lots of people seem very concerned about the “impact” on those earning just over £42,475 should their child benefit be removed.
Yet strangely, nobody seems remotely concerned about the much greater impact on those 82,000 low-income families who will lose their entire £3,870 working tax credits when the part-time hours threshold is raised from 16 to 24.
Why no urgency about that? In fact, when I raised this on LDV a few weeks ago, the reaction I got was: “tough”.
There is an obsession at the moment with helping those in the middle (or some way above the middle) which contrasts uneasily with disregard for those at the bottom. A cynic might say this has more to do with electoral demographics than fairness.
@Joe Bourke
“The second is that the marginal rates of direct tax should not exceed 50% at any point in the income range”
It doesn’t. That’s not my opinion, it’s a straightforward fact. The highest marginal rate of direct taxation on income is 50% at the moment.
@Tom Papworth
Where is the evidence to support your assertion that those on 100k income pay 62% in taxation? I simply don’t believe that figure. It can only have come about because of counting an excessive nbumber of transactions as cash circulates around the economy and not taking into account the economics of who pays VAT (economically, around two thirds of VAT is paid by the seller ), and a wholse host of other taxes.
The direct taxation on income a person on 100k income is ~35% presently. If those on 100k actually did pay 62% of their income in tax (in aggregate: direct + indirect taxation), the budget deficit would be slashed.
Stuart,
I believe the issue has been flagged up by child poverty campaigners. As I understand it, until the Universal credit system begins in 2013, some families may be better off on benefits than working. Couples with children that would no longer qualify for the extra money could see their income drop from £330 a week to £257 a week – £14 a week less than an equivalent family with no adult working.
The 24 hours a week requirement is a combined total for husband and wife and this particular benefit is designed as both an incentive and income supplement for those in work. Nevertheless, in this difficult employment environment, it would seem sensible to phase in this change with the start of the Universal credit system in 2013, to avoid temporarily putting families in a position where work does not pay.
Steve,
the term ‘marginal rate of tax’ referes to the effective rate of deduction you suffer on an incremental slice of income. Tom Papwoth has referred above to the use of the term in the benefits system – “… the combination of taxes and benefit withdrawal for people earning in the high thousands but below £10,000. I think the withdrawal rate (which is in effect the same as the marginal tax rate) is something like 74%.”
The personal allowance is gradually withdrawn for income over £100k at a rate of £1 of allowance lost for every £2 over £100k until it is completely removed. The effect is a marginal deduction rate of 60% on this slice of income betwen £100,000 and £114,950. Add to this rate the 2% national insurance paid on earnings over £42,475 and you have a marginal rate of 62%.
Chris,
“I’m baffled. You’ve written an article entitled “Let’s raise tax threshold for all taxpayers”, but you say you’d rather put the money into a job guarantee scheme.
Shouldn’t the article have been entitled “Let’s introduce a job guarantee scheme”?
It’s here Job guarantees.
I see Ed Milliband has floated Labour’s ideas for a job guarantee scheme in a speech today.
Labours job guarantee scheme? And if you don’t take a job your benefits will be withdrawn. Which brought howls from the usual suspects.