As the UK gears up for a pivotal General Election in 2024, the discourse surrounding personal tax levels takes center stage. Both major political parties face the delicate task of balancing promises of tax cuts with the imperative to bolster public services. Complicating matters further is the nation’s current recessionary state, potentially constraining the Treasury’s tax revenue and limiting the scope for tax relief or substantial investment.
In the realm of taxation, the principle of progressivity dictates that the affluent shoulder a greater portion of their income in taxes compared to their less affluent counterparts. Yet, determining who qualifies as “rich” and evaluating the extent of their tax burden remains a subject of scrutiny.
One illuminating metric is the analysis of Income Tax receipts, particularly focusing on the proportion of taxpayers categorized within higher tax bands. Historical data from HM Revenue and Customs (HMRC) spanning over three decades unveils a striking trend: the share of UK taxpayers subjected to the higher 40% tax rate or beyond has surged from a mere 6.5% in 1990/91 to 18% in 2023/24. This escalation signifies a substantial shift, with approximately one in fifteen taxpayers being subject to higher rates in 1990, swelling to more than one in six today.
While the overall number of income taxpayers has increased by 38% since 1990, primarily attributed to population growth, the surge in higher rate payers (including additional rate payers in applicable years) has ballooned by a staggering 280%. This phenomenon, known as fiscal drag, ensues from successive governments neglecting to adjust tax thresholds in tandem with wage inflation, culminating in a protracted, multi-decade tax ascent that significantly enriches the Treasury.
Recent years have witnessed an acceleration of fiscal drag, exacerbated by the freeze imposed on the thresholds for commencing higher (40%) and additional (45%) rate taxation since 2021. This freeze, extended in 2022, translates into taxpayers facing a 40% tax liability on earnings surpassing £50,270, and a subsequent 45% rate on earnings exceeding £125,140, until at least 2028.
Although burdensome for taxpayers, fiscal drag serves as a formidable revenue-generating tool for governments, particularly during periods of rapid wage escalation. The Office for Budget Responsibility predicts that the freeze on Income Tax bands will yield an additional £29.3 billion by 2028.
While employees face limited recourse against frozen income tax bands, strategies exist to mitigate their impact. Leveraging earnings to contribute to a pension represents one such avenue, as contributions receive a 20% tax relief from the government, with higher and additional rate taxpayers potentially eligible for greater benefits via Self-Assessment.
Under the 2023/24 tax year Annual Allowance, taxpayers can secure tax relief on contributions up to a maximum of £60,000, capped at their earnings if lower. Notably, pension contributions enjoy exemption from Capital Gains Tax (CGT), and upon eligibility, 25% of the pension pot (up to £268,275) is accessible tax-free, with surplus withdrawals subject to income tax.
In navigating the landscape of taxation characterized by a slow-motion tax grab, understanding available avenues for tax mitigation assumes paramount significance for taxpayers across the spectrum. As the fiscal discourse evolves, strategic financial planning emerges as a vital tool for navigating the complexities of the contemporary tax regime.
