What rate of tax do you pay? A simple question?

Latest statistics from HMRC show that tax receipts from PAYE income tax and Class 1 NIC amount to £37.9 billion in April 2022, which is £6.5 billion higher than the same period last year. This is a significant increase, far beyond the normal year-on-year increase in tax when looking at the same period.  

There has been a lot of discussion about the recent 1.25 per cent increase in the rate of National Insurance Contributions (“NIC”), brought on by the government’s health and social care levy. However, the latest tax receipt figures do not include the include the NIC increase that was introduced in April 2022. The additional revenues from this will be taken into account in next month’s figures and are likely to increase even more as a result.

Many will be unclear on what is driving these ever-increasing tax receipts. The complexity of the tax rules can leave them in the dark on what tax is paid on their income. The changes to the NIC regime made in April 2022 have led to a great deal of comment around tax rates – but what tax rate do people really pay? 

For example, if an employee is paid a salary of £25,000 and their employer has £1,000 to pay them a bonus, because of the employers’ NIC at 15.05 per cent (the highest rate of NIC to date), a bonus of £869.19 will cost the employer £1,000. The employee will then pay 13.25 per cent employees’ NIC and income tax at 20 per cent, leaving the employee with £580.18 – an effective tax rate of just short of 42 per cent.

So, what happens when the dreaded higher rate tax threshold kicks in when income exceeds £50,000? Whilst income tax increases to 40 per cent, the employees’ NIC falls to 3.25 per cent. The effective overall tax rate goes up from around 42 per cent to nearly 51 per cent. Not as big of an increase as people would imagine but still more than half of the bonus is paid in tax.  

Compare that with the multi-millionaire living off rental income. The basic rate taxpayer pays 20 per cent and the higher rate taxpayer 40 per cent – there is no NIC (or health and social care levy) on rental income. The additional rate taxpayer – someone with total income over £150,000 – pays 45 per cent. A lower rate than an employee earning far less.  

Is it time for a radical overhaul of the tax system? We do not have the progressive tax rates we think we have, and it is hard to see the justification for paying different rates of tax on different types of income. Until the mid-1980s NIC was a fairly minor tax. Now, for many people, when including the employers’ NIC, they pay more NIC than tax.