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Do you realise you’re paying more income tax?

Income tax

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:

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.

Taxing matters

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.

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{ 13 comments… add one }
  • 1 Samurai April 13, 2010, 1:13 am

    Oh my gosh! You guys are raising the top marginal tax rate by ten percent to 50%??? That’s freaking ridiculous! Remind me never to work in London! I feel so bad for Hard working English people now, and feel somewhat better for we Americans paying 40%!

  • 2 Financial Samurai April 13, 2010, 7:22 am

    Did my comment not go through?

    I’m shocked your tax rate is going to 50% from 40%!
    .-= Financial Samurai on: Why Isn’t President Obama Considered White to The World? =-.

  • 3 The Investor April 13, 2010, 7:59 am

    It’s true, the UK is now worst from a personal taxation perspective of any of the major economies – worse than France and Germany, even. You get San Francisco AND you get to keep more of your money. No fair! 😉

    The 50% rate was meant to be temporary, mind, to pay for ‘the crisis’, though I’ll believe it when I see.

  • 4 The Investor April 13, 2010, 8:19 am

    @Sam – Re: Your comment, I use first-time comment moderation on the blog and you’d used a different email address for that first one, hence it was held in a queue while I slept! 🙂

  • 5 Simple in France April 13, 2010, 3:21 pm

    Interesting! Thanks for detailing all like that for those of us unfamiliar with UK tax code. I was always in the 25% tax bracket back in the States, but I do realize that you don’t really feel rich earning over 100k in California–higher cost of living states are a bit of a trap in that sense–you may earn a higher salary to cover your expenses, but then you have to pay out the nose to the federal gov.

    It made me laugh when you mentioned the UK being worse than France–sounds like it! But then again, people here are very angry/unsettled at the fact that the wealthiest recently got a pay cut during the economic crisis. . .I won’t be able to vote here until some bureaucrat in Paris stops drinking coffee long enough to consider my application for nationality, so I have some time to think it all over 😉
    .-= Simple in France on: Pinching Pennies, Indulging in Luxuries =-.

  • 6 Niklas Smith April 13, 2010, 4:38 pm

    …the UK is now worst from a personal taxation perspective of any of the major economies.

    Only for very high earners, surely? Taxes on middle incomes (say £20,000-25,000 per year) are surely higher in France than here, especially if you include social security contributions.

    The 50% rate was meant to be temporary, mind, to pay for ‘the crisis’, though I’ll believe it when I see.

    Yes that sounds familiar! In Sweden in the 1990s a 55% extra rate of income tax was introduced (until then the top rate was 50%) as a “purely temporary measure” to help bring public finances back in order. And it’s still levied today…

    I do have one serious point to make, though. You write “These two measures together could cost a middle-class Monevator reader just shy of £500 over the next 12 months”, but how is it that “middle class” is defined as “the top 4% of income taxpayers” (which is the proportion of taxpayers in the top rate)? The real “middle England” (i.e. people with incomes around the median) is rather different, as this very interesting article in the Economist pointed out: http://www.economist.com/world/britain/displaystory.cfm?story_id=15777629

  • 7 Samurai April 13, 2010, 8:26 pm

    Gotcha. How temporary did they said it would be?

    You guys got $2 BILLION from foreigners due to your 50% bonus tax on anyone making over 50KUS a year… now that’s ludicrous.
    .-= Samurai on: Why Isn’t President Obama Considered White to The World? =-.

  • 8 The Investor April 13, 2010, 10:10 pm

    @Sam – Well, as we’ve discussed many times, that only applied to bankers. I agree it was ludicrous – ludicrous that the banks still paid staff the bonuses! (They only had to wait a year, or else pay options or similar. But no). Interesting stat on the tax on overseas workers… source would be interesting.

    @Niklas – Interesting article. It says: “The 40% rate of income tax […] catches just 3.8m of Britain’s 31.7m income-taxpayers.

    So that is fewer than I thought, I admit. But I have the benefit of access to Monevator’s stats – about half the site’s audience is from the UK, and of those about half that readership is in London! I suspect we skew higher. In my experience the 40% rate is not at all hard to hit on a London salary – not a bank/fund management salary, I mean just a general ‘big city’ job like media, marketing, sales, accountancy, law, etc – before your 30s.

    Also, I don’t think you start thinking about investing and ISAs and the like until you approach the higher rate tax bracket (unless you are a money nerd like, dare I say, us? 😉 ), though I could be wrong – and to be clear I definitely welcome everyone! 🙂

    Re: The tax rates, yes, I’m talking about the highest rates of income tax. Should have made that clear – I’d give a source, but my source is a short item on CNBC TV!

  • 9 Financial Samurai April 14, 2010, 3:43 pm

    Monevator, what about those who work at investment banks, who DON’T live in London, who had to take 5-10% hits on their bonuses just b/c of your countries Socialistic rule? That can’t be fair can it? Or can it? And if it is, here’s hoping the gov’t raises taxes on more and more English folks! 🙂
    .-= Financial Samurai on: Over The Hill At 40 – Age Discrimination In The Workplace =-.

  • 10 The Investor April 14, 2010, 7:35 pm

    Of course it can be fair. What’s fair anyway? You’re the proponent of ‘everything is rational and happens for a reason’, no? 🙂

    Work for a bank that makes easy-peasy money by leveraging to the hilt in the good times and enjoy a largely unearned mega-bonus on top of your (earned) salary.

    Get bailed out when it goes bust and see your bonus curtailed after banks everywhere (including in the US) are only still functioning because of massive state support.

    Sounds pretty fair to me.

    By the way Sam, you’re *so* obviously a banker, it’s clear in all your views (including the conversations about your friend who won’t leave McKinsey). But fear not, I won’t hold it against you, you’re a top bloke. (If it’s a secret let me know and I’ll edit this comment!)

    Besides, some of my best friends are… etc! 😉

  • 11 Samurai April 14, 2010, 9:08 pm

    Ha, if I was a banker, I’d have no life and wouldn’t be able to ever write anything! Besides, if I were a banker, as you say, I’d be so mega rich I wouldn’t bother with associating with the masses 🙂

    I live in SF, one of the most innovative places in the world. It would be a shame to be a banker.

    What do you do again?
    .-= Samurai on: Over The Hill At 40 – Age Discrimination In The Workplace =-.

  • 12 The Investor April 14, 2010, 9:20 pm

    Hmm, I have to admit the San Francisco angle had thrown my theory a bit… then again I’ve been to the financial district in SF – perhaps you work in that cool sci-fi triangle building?

    Okay, you’re a retired banker. 😉

    I do various bits and pieces these days, as a freelance, mainly related to the geekier end of the media, mostly for the lifestyle and because it interests me (and because I’m too wary to start another business at the moment) as opposed to the money earning potential. I hit the UK higher rate tax bracket several years ago (so in roughly 15% of UK population) but I don’t make a megabucks income at all, and in London (i.e. City) terms my income is pretty paltry.

  • 13 James February 11, 2011, 9:07 pm

    Why do you think Bliar and Thatcher live in the USA. Bliar actually took us into an illegal war to secure contracts and positions with oil companies and banks paying millions. But as he resides in the USA, he has effectively dodged UK taxes. Bankers defer bonuses etc. but in the year they retire, they will accept them, including the deferred bonuses, as this will push up their final salary for pension purposes. In effect, they will be getting humongus pensions that they didnt earn, or pay enough into the pension fund to receive. One day, these pensions will crash as these execs bleed them dry.

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