Why the 45% income tax cut fell flat

It is easy to assume that many entrepreneurs would have been in favour of the 45% income tax cut announced by the chancellor in the mini budget, as they may have been able to benefit from it. The reality is that the response from many business owners was lukewarm at best. So why did the measure fall flat with some of the intended beneficiaries of the measure?

When the 45% tax cut measure was announced, some parallels were drawn with the 50% income tax rate and the circumstances that led to that being scrapped. Some individuals did find a 50% income tax rate a highly emotive issue, uncomfortable with the idea that, when combined with national insurance, over half of their earnings were being paid to the Treasury. At the time, that undoubtedly drove some individuals to seek out ways to minimise its impact and it distorted some taxpayers’ behaviour.

In contrast to the 50% income tax rate, the 45% rate has not featured as high on taxpayers’ agendas. Whilst some may consider it still to be high, according to OECD statistics, the UK’s top rate of income tax compares favourably to other major nations, firmly in the middle of the pack. In practice, there simply was not an expectation from many entrepreneurs that this cut would be made and the demand for it was muted.

The reality is that many entrepreneurs would not be incentivised by a 40% income tax rate, any more than a 45% income tax rate. For many, if there is a tax that plays a factor in building their business, it is more likely to be capital gains tax rates than income tax. Rather than paying out very large salaries or dividends, many business owners will choose to retain and reinvest profits in their company rather than pay it all out as income. The objective is often to build towards a sale or another exit from the business and receive a large capital lump sum, usually taxable at a rate of no more than 20%.

Since the substantial changes to Entrepreneurs’ Relief in 2020, dubbed at the time by the Resolution Foundation as the ‘UK’s worst tax break’ and rebranded as Business Asset Disposal Relief, there have been limited tax incentives to encourage the “free the potential” of “our entrepreneurs, our business people, our job creators” as the chancellor stated in his conference speech.

Whilst the measures around the Seed Enterprise Investment Scheme announced in the mini budget have understandably received limited attention, it may be that sort of policy that might appeal to entrepreneurs. Whilst a tax relief on the sale of businesses has received criticism in the past, perhaps more reliefs to encourage more reinvestment of sale proceeds into businesses by entrepreneurs could be the answer. What has been made absolutely clear over the last week is that, rather than rushed through policies, what is needed is proper research and analysis into what will drive a new wave of entrepreneurs at this time of economic uncertainty.