As the new tax year starts, having thresholds in the tax system which do not rise with prices means increasing numbers of people are being drawn into higher tax bands in a way which is neither planned nor transparent, the Institute for Fiscal Studies (IFS) is claiming
Its analysis shows that the year before the new top income tax threshold of £150,000 was announced, there were 319,000 taxpayers with incomes above that level. The threshold has not moved since it was introduced in 2008 and there are now 428,000 individuals with incomes above that level, an increase of more than one-third.
In the same year, the income tax personal allowance started to be withdrawn once income hit £100,000, creating a 60% marginal rate band. Before it was announced, there were 647,000 individuals with incomes over £100,000; today there are 986,000, an increase of more than half.
Had these thresholds moved up in line with inflation, they would now stand at £180,000 and £120,000 respectively.
The think tank says the failure to index the £50,000 point at which child benefit starts to be withdrawn affects even more people. It creates a 65% marginal income tax rate on incomes between £50,000 and £60,000 for people with three children, for example, and will soon affect one in five families with children, compared with one in eight when first introduced.
Other parts of the tax system are also being frozen in nominal terms, including the inheritance tax threshold, which has been fixed at £325,000 since 2009–10. The VAT registration threshold has been frozen at £85,000 since April 2017, and the last Budget announced that it would remain frozen until April 2022.
Meanwhile the £100,000 threshold at which eligibility for ‘tax-free childcare’ is removed is not adjusted for inflation, and the £110,000 and £150,000 thresholds at which the annual limit on tax-privileged pension saving starts to be reduced are fixed in nominal terms.
IFS argues these pension saving thresholds can create very high marginal tax rates and, as the thresholds are frozen from year to year, they are gradually affecting more people.
Paul Johnson, IFS director, said: ‘By freezing the thresholds at which child benefit is withdrawn, the personal allowance is withdrawn and the top rate of income tax applies, recent governments have, rather stealthily, increased the tax rates on high earners and the number of people facing high marginal rates of tax. If government thinks there is a case for more high-income people to pay more tax, it should be upfront about that view.’
For some in generous but inflexible public sector pension schemes, these limits can also create the absurd situation where a salary increase can leave someone considerably worse off, the IFS says. This can happen when earnings (excluding pension contributions) move above £110,000 and the value of pension contributions is more than £40,000.
This can trigger an increase in tax that is much bigger than the increase in salary, and is behind a number of resignations by hospital consultants affected by the rules.
Stuart Adam, a senior research economist at IFS, said: ‘Some might struggle to shed a tear for the plight of high earners with good pensions. But nobody’s interests are served by encouraging them to work less in order to keep their income below an arbitrary threshold. And as these thresholds are frozen while incomes rise, these pernicious incentives become relevant to an ever-wider group of people.’
Report by Pat Sweet