Chancellor Jeremy Hunt is being encouraged to use the unexpected £5.4bn surplus reported in January to cut taxes in the Budget.
But that is not the only money he has to play with. He could raise almost £30bn by ending some anomalies and use that to begin to thaw frozen tax allowances to benefit every taxpayer.
It used to be that unearned income was taxed more heavily than income earned from employment. Unearned income comes from capital – dividends on shares, capital gains and rents.
Some of those may involve some work on the part of the owner but they are not earnings in the sense of being an employee or self-employed.
In 1972, Conservative chancellor Anthony Barber introduced a surcharge on investment income of 15%. It was finally abolished by Nigel Lawson in 1984.
Raising tax on dividends towards the standard rates would bring in around £1bn for each 1.25 percentage points
Now, of course, the opposite is true. Unearned income is taxed more lightly than taxes on wages. Tax on income above the personal allowance earned from employment is 20% and another 12% is paid in National Insurance contributions (NICs), so full time employees work until after lunch on Tuesday to pay the taxes on their earnings.
Unearned income is taxed less. First, there are no NICs on income from rent, dividends or capital gains – a saving of 12%. Second, the rates of tax on dividends and capital gains are far less than the standard rates of income tax.
Dividend rates are 8.75% at basic rate, 33.75% at higher rate and 39.35% at top rate – all at a big discount off the 20%, 40% and 45% on earned income. Raising tax on dividends towards the standard rates would bring in around £1bn for each 1.25 percentage points.
A start could be made by adding 5.65 percentage points to bring the top rate up to 45%, the higher rate to 39.4% and the basic rate to 14.4%. That would bring in £4.5bn. Dividend taxpayers would still benefit from the extra £1,000 tax free allowance in 2023/24, though that will be cut again to £500 in 2024/25.
The standard rate for NICs is 12% but the rate is slashed to 2% on earnings over £50,270. The opposite of progressive taxation
The personal tax allowance of £12,570 does not apply to capital gains. Instead, there is a special tax-free allowance, currently £12,300 but due to be slashed to £6,000 from April and halved again to £3,000 from April 2024.
The tax rates above that are currently 18% on gains on a residential property and 10% on other gains for basic rate income taxpayers, with higher rates of 28% and 20% for higher and top rate income taxpayers.
Increasing those raises about £1bn for each overall percentage point increase. Most of that comes from higher and top-rate taxpayers. Bringing those up to standard rates of income tax could raise over £10bn a year.
The chancellor should also end the enterprise investment scheme, seed enterprise investment scheme and venture capital trust tax reliefs, which are used by a few tens of thousands of people in the top income decile to avoid tax they would otherwise pay. Between them, they cost the rest of us around £1bn a year.
The freeze means basic rate taxpayers will pay an extra £340 in the year and higher rate taxpayers an extra £1,720
The standard rate for NICs is 12% but the rate is slashed to 2% on earnings over £50,270. The opposite of progressive taxation. If that was raised to the standard rate, £11bn would hit the chancellor’s coffers, with another £1.6bn from the self-employed.
That assumes the self-employed continue to pay just 9% standard rate for their NICs, even though they get virtually identical benefits. Their state pension, which takes the bulk of the money paid in NICs, is the same (before 2016/17 it was often less) and they get equal bereavement and maternity benefits.
The case for the lower standard rate can no longer be made and raising it to 12% would bring in £1.7bn a year from the self-employed on top of the savings from ending the 2% rate.
Those changes raise almost £30bn. It sounds a lot but is exactly the amount snaffled in 2024/25 by the six-year freeze on tax allowances. The personal tax allowance of £12,570 and the threshold for higher rate tax of £50,270 were last fixed in 2021/22 and, under Hunt’s current plans, will not change again until 2028/29.
If these allowances had risen with inflation, as the law says they should, then from April the personal allowance would be £14,270 and higher rate tax would begin at £57,170.
The freeze means basic rate taxpayers will pay an extra £340 in the year and higher rate taxpayers an extra £1,720. Those frozen thresholds also apply to NICs and the Office for Budget Responsibility estimates the big freeze will bring in an extra £150bn over the six years to 2027/28.
Money taken from every taxpayer. Time to start giving it back.
In Scotland there is also a freeze on allowances. Higher rate tax begins at £43,662 on earned income, rents and pensions. But higher income tax rates rise by one percentage point in April to 42% higher rate and 47% top rate.
Paul Lewis is a financial journalist and host of Radio 4’s Money Box
Paul Lewis continues to impress with well reasoned argument… however, it might be worth considering two factors re dividends – 1, To pay a dividend, 19%, soon to be 25%, has already been paid upon the profits required for a distribution unless borrowed funds are used; 2, There is the risk factor to consider – peoples’ money invested into companies which provide the jobs…etc…!!
To be most effective, Government should ignore BofE and back wages and salaried (indivduals), and cease the seemingly unlimited money available for asset support…QE… This could be done by loaning householders funds, secured upon their assets, to spend by covering or guaranteeing, say, half their mortgage payments.
This would, 1. Support financial institutions in any event; 2. Create more confidence; 3. Immediately release more cash for inflated bill payments, 4. Be relatively low in stoking inflation.
Folks should remember it was Andrew Bailey in November 2021 who insisted that there was ‘no point in putting up interest rates’ as inflation increases were ‘supply side’. Three weeks later, BofE put up interest rates for the VERY first time in a December month – and have yet to stop.
There is nothing wrong with an independent BofE, as long as the guy with hand on tiller knows what he is doing. Clearly, the current Governor does not – one only has to think back to his time as head of the FCA, where saying something was unregulated meant that the FCA had no interest in the real world of fast and loose marketing…E.g. London Capital. Methinks, the FCA was there to stop such matters – non??
57% income tax Paul?
You’ve regressed to full Corbynista territory!
“regressed to full Corbynista territory” … no, I don’t think so – he has always been there!
The Annual HMRC tax free allowance even penalises those on the minimum wage and so then they have to claim benefits, this cannot be right or good Govt. governance surely?