As of April 6th 2010, income tax in the UK has effectively gone up. But a straw poll of my friends over the weekend suggests most people haven’t noticed.
It’s easy to see why:
- The new 50% income tax rate only applies to those earning more than £150,000 a year.
- The extra 1% in National Insurance contributions will effectively be a 1% income tax rise. But NI rates don’t go up until next year.
So where’s the tax rise?
Well, this is Gordon ‘Stealthy’ Brown we’re dealing with here, remember.
Far too cunning to increase income tax rates just before an election, he’s instead letting what’s called ‘fiscal drag’ raise some extra revenues for him.
Stealth rise 1: Frozen personal tax allowance
You are taxed 20% on your earned income above your personal allowance. This percentage rate has not increased.
However the personal allowance for 2010-11 is £6, 475, which is the same as it was last year.
- If the personal allowance had been raised with inflation as usual, it would have gone up to £6,669.
It wasn’t raised with inflation, so you’ll pay tax on an extra £194 of your hard-earned income.
Admittedly, that will only amount to £38.80 in extra tax at the 20% rate, but it all adds up, especially as any Labour Government is unlikely to lift the allowance back above inflation one day to make up for it. (Yet the same Government has rightly stressed the benefits of increasing ISA limits with inflation).
If you’re earning over £100,000 a year, you probably know your wallet is being tapped extra hard.
- Starting this tax year, the personal allowance reduces where the income is above £100,000 – by £1 for every £2 of income above the £100,000 limit, and irrespective of age.
It’s this tapering effect that is producing the marginal 60% tax rate you might have heard accountants and the like discussing, for those earning over £100,000.
(If you’re over 65, you get special allowances. See the HMRC income tax page for these and other details).
Stealth rise 2: Frozen higher-rate tax band
It’s true that the 40% higher tax rate has only gone up for those earning over £150,000 – to 50%.
However, more people will more income taxed at the higher rate, again because of fiscal drag.
You start paying higher-rate taxes at £43,875, just like last year.
- If instead the starting level had risen with inflation, it would be £44,995
The difference is £1,120, so you may well be paying an extra £448 in income tax this year, compared to if the rate had not been frozen.
This despite the actual percentage rate of tax being left unchanged.
These two measures together could cost a middle-class Monevator reader just shy of £500 over the next 12 months, compared to if the bands had been risen with inflation. And yet the Government has correctly guessed most people won’t notice, because they won’t have less money than last year.
Such is the power of money illusion!
Everyone knows the UK finances have to be sorted out, and we saw when the would-be Chancellors debated that nobody is being straight about it.
I urged spending cuts in the comments to that article, but others prefer tax rises and it seems the public does, too.
So what can you do to avoid paying more taxes if you believe the state is already taking more than enough of your money?
- Firstly, you can use tax shelters and other methods to invest more tax efficiently, as I discussed in my recent article on avoiding capital gains tax.
- Secondly, you can vote for a low-taxing party. (There’s an election on!)
We may get more clarity about the parties’ taxation and spending plans over the next few weeks, but for now you could try using this pre-election salary calculator. It seems a bit simplistic and it hardly covers the range of stealth taxes and so forth, but it’s better than nothing.
What party will suit you depends on your own salary details. For instance, the Liberal Democrats plan a £10,000 personal income tax allowance, which for lower earnings will greatly increase your take home pay.
In fact, the Liberal Democrats seem to win among the main parties for take home pay up to £50,000. (UKIP does slightly better).
Personally, I wouldn’t vote for a party just on the basis of my own taxation.
Indeed, I’d even vote for a party who said it was going to temporarily raise my income tax, if it was a short-term measure to fund the dismantling of a significant chunk of long-term state spending.
But that’s a matter for each of us to decide in the polling booth.
Just be aware that you’re already paying more income tax than you might have expected, and that without spending cuts you’ll be paying even more in years to come.