Chris Etherington

Written by: Chris Etherington

Chris Etherington

Partner

Heard of the 60% tax rate? Welcome to 67.5% income tax!

It has been widely reported that one of the measures that the chancellor could introduce in the Autumn Statement is lowering of the threshold at which individuals pay 45% income tax from £150,000 to £125,000. Based on our calculations, such a move could result in an estimated 180,000 taxpayers paying 45% who were not doing so before and could generate over £500m in extra revenues for the Exchequer. These are broad estimates as HMRC does not currently publish up-to-date data that is broken down to allow for precise calculations.

In broad terms, such a measure would represent another 5p in tax for every pound of income over £125k so for someone on a salary of:

  • £150k, they would pay an additional £1,250;
  • £140k, they would pay an additional £750;
  • £130k, they would pay an additional £250.

That does not however paint the full picture and there would be some unintended consequences of such a move. 

The chancellor clearly does not want to be seen to increase the headline rates of tax, but this measure is a poorly concealed alternative. It is a tax rate hike in all but name. This measure will also unnecessarily complicate the income tax rules even further.  Those who break through the £100,000 income barrier already face a penal effective rate of income tax of up to 60% due to the loss of the personal allowance.  With this change, some will see a small amount of their income taxed at an astronomical effective income tax rate of 67.5% instead, and potentially even higher north of the border.

Working through the numbers as to how we reach these figures, currently, income between £100,000 and £125,140 can suffer an effective rate of tax of 60% due to the reduction in the personal allowance as income exceeds £100k. That’s calculated as £1 of allowance lost for every £2 of income over £100k.

Take the example of an individual with an income of £130,000. They would pay 40% income tax on the slice of income from £100,000 to £125,140, and then a further 40% on the £12,570 of personal allowance lost. The income tax due is therefore £10,056 and £5,028 respectively, totalling £15,084. From the original £25,140, the taxpayer is left with £10,084, effectively suffering income tax at a rate of 60% on this slice of income. 

With the new band, someone with income of £125,140 will have £140 of that income taxed at 45%, together with an equivalent loss of personal allowance of £70 also taxed at 45%. Using the same calculation, that results in an effective income tax rate of 67.5%. The position is potentially even worse in Scotland as their additional rate of income tax is 46%, meaning the same effective income tax rate is 69%.

Whilst there would only be a relatively small amount of income taxed at this new penal rate of 67.5%, this will undoubtedly increase over time when the personal allowance eventually thaws out and increases with inflation again. This is an anomaly in the income tax system that needs to be looked at from both a simplicity and fairness perspective. Rather than addressing this long-standing issue, the chancellor could compound it in the pursuit of short-term revenues.

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