The wider implications of extending the basic rate band

‘There is no such thing as a new idea... we simply take a lot of old ideas and put them into a sort of mental kaleidoscope…but they are the same old pieces of coloured glass’. Following recent reports of a potential increase in the basic rate income tax band to £80,000, taxpayers might be forgiven for thinking the new prime minister Liz Truss is taking Mark Twain’s quote a little too literally.

However, it is not a case of the public suffering déjà vu en masse. The headline-grabbing measure announced by Boris Johnson during the Conservative Party’s 2019 leadership race is reportedly being given fresh consideration.

Much of the criticism of the policy in 2019 focused on the fact it would benefit higher earners, with the tax strategy later shifting to a policy of increasing national insurance thresholds and a focus on lower income earners.  

The overall saving from such a policy now is likely to amount to a maximum of just under £3,000 per individual with an income falling between £50,270 and £80,000. That may not be as high a saving as some expect. This is because the rate of income tax would reduce by 20% on this income but in turn, individuals’ national insurance contributions (NIC) are likely to increase by 10% on the same amount. This assumes income tax and NIC thresholds would continue to be aligned.

A key difference from 2019 that might prove attractive to Ms Truss and her new chancellor is that the policy could help reverse the impact of fiscal drag in the last few years which has brought more individuals into the higher rate tax band.

Latest statistics suggest that in the year to 5 April 2023, there will be 5.51m higher rate taxpayers in the UK – a 15% increase on the 4.76m higher rate taxpayers in the year ended 5 April 2022. More specifically, further statistics show that the number of individuals with an income between £50,000 and £100,000 has increased from 3.55m to 4.95m since the 2019/20 tax year. The total income tax paid by people in this income bracket has increased from £44bn to £61bn over the same period, a staggering increase in three years.

If there was a desire to do so, it would also be relatively simple to structure a change in tax thresholds so the benefit was much more limited and targeted at those with income under £100,000. This might be done, for example, by reducing the threshold at which additional rate income tax at 45% becomes payable to £100,000, resulting in the majority of the £3,000 saving being eliminated for those with higher incomes. 

There are always unexpected consequences that can arise from a major change in tax policy like this. For example, by increasing the basic rate band, some earners will miss out on higher rate tax relief on their pension contributions and receive relief at the basic rate of 20% instead. Another consequence is that any major changes to the higher rate tax threshold could widen the differences between the income tax system in Scotland and the rest of the UK.  

Powers over income tax rates and the thresholds at which tax rates apply have been devolved to Scotland and powers over income tax rates have also been devolved to Wales. Whilst to date the Welsh income tax rates have mirrored the UK headline rates, the income tax system in Scotland has diverged from the rest of the UK, with more tax being paid by higher earners in Scotland than in the rest of the UK. Although the current differences in the tax system are unlikely to distort the behaviour of Scottish taxpayers, significant changes could lead to some middle-earners considering whether to make a move across the border. 

So, there is plenty for the new prime minister and her chancellor to ponder over the coming weeks. The question is whether the desire to set a fresh agenda quickly will outweigh the need for detailed and measured consideration of the consequences.