Our real top income tax rate is 60% – and it’s not the highest earners who pay this
It’s astonishing that the 60 percent tax trap imposed a decade and a half ago still exists.
In April 2009, against the backdrop of emergency financial measures, Chancellor Alistair Darling announced that the personal allowance would be abolished at a rate of £1 for every £2 earned over £100,000.
This created Britain’s highest effective income tax rate of 60 percent.
It is widely regarded as one of the most perverse and unfair parts of our tax system. And yet, almost fifteen years and seven Conservative Chancellors later, the 60 percent tax rate remains in place.
Sting: Abolition of personal allowance will create a 60% income tax trap between £100,000 and £125,140
Of course, it is not an official income tax rate. Currently these are 20 percent, 40 percent and 45 percent.
But in reality, the income tax system is structured so that the rates are 20 percent, 40 percent, 60 percent, 45 percent.
Someone with an income of £100,000 may earn a lot of money, but those in this category pay a higher marginal tax rate – that of the next pound earned – than people who are paid much more.
The current 60 per cent band is between £100,000 and £125,140, at which point the personal allowance will disappear completely and the marginal tax rate will return to 45 per cent.
It works like this. If someone earns £100,000 and gets a £5,000 pay rise, they lose 60 per cent in income tax. Whereas, if someone earns £200,000 and gets a £5,000 pay rise, they lose 45 per cent of that in income tax.
Obviously this is crazy.
What makes it even crazier is that the £100,000 threshold hasn’t changed. If it had risen with inflation since 2009, it would now be £153,000.
So why on earth has nothing been done about this?
I think the answer lies mainly in two elements:
Firstly, it is very difficult to gain sympathy for people who earn £100,000 a year.
Second, in the years since the financial crisis, politicians have been terrified of doing anything with taxes that might give the impression of favoring rich people — even if that tax is patently stupid.
And so for 15 years, we’ve had a bad tax that has not only remained in place, but has gotten even worse as a result of the budget delay.
Politicians are terrified of doing anything with taxes that could be perceived as favoring rich people – even if that tax is patently stupid
A similar problem has also been ignored further down the income scale, with the abolition of child benefit between £50,000 and £60,000.
This creates a marginal tax rate of 51 percent for a parent with one child, or 59 percent if he or she has two children.
It affects couples where only one parent’s income exceeds that level – although both could earn £49,999 and be fine.
Again, the threshold has not changed in the eleven years since George Osborne introduced tapering; if it had, the threshold would be £67,000.
As you may have guessed from a column that began with a look back at 2009, these tax traps are not new news.
This kind of unfair treatment undermines the tax system
You may have heard me complain about them before. This kind of unfair treatment, which undermines the tax system, is a pet peeve of mine and I have been complaining about both for years.
What’s interesting now is that there seems to be a groundswell of opinion that we should get rid of these tax traps.
The general tone of the reader comment debate over our articles on the abolition of child benefit and the 60 percent tax has shifted from a lack of sympathy for the high earners to annoyance and anger at these pernicious parts of the tax system.
This is evident from the comments on Steve Webb’s latest column, in which he answers a reader’s question about whether paying into a pension can beat the 60 percent tax.
After all, surely a chancellor has to be brave enough to sort out this mess?
The next Budget is now less than a month away, so will Jeremy Hunt be that bold Chancellor?