So much for simplification – we now have four types of income tax
There's no silver bullet to this muddle of complexity, and workers, savers and shareholders are all paying the price
You’ve got to pity the poor souls at the Office of Tax Simplification. Quite possibly the least sexy quango of all, the Government’s tax adviser is tasked with coming up with ways to streamline Britain’s ever more bloated taxation rulebook. Removing duplication, aligning rates and simplifying guidance is the aim of the game.
Picture the scene in the OTS on Tuesday, then, when the Prime Minister delivered a slew of tweaks and fiddles to National Insurance and dividend levies as well as a brand new health and social care tax. Their heads must have exploded. Or maybe accountants live for this stuff, the more complex and impenetrable the better.
All of which means that, despite appearances, there are now effectively four separate levies on earnings, only one of which has the word “income” in it. To add to income tax we have National Insurance, student loan repayments (better called a graduate earnings tax) and the new 1.25pc health and social care levy.
However - and you can practically hear the OTS bods rolling their eyes - for the first year of the new tax’s life it will exist as part of National Insurance, so the main NI rate will go from 12pc to 13.25pc and the top rate from 2pc to 3.25pc and then drop back as before.
From April 2023 state pensioners with earned PAYE income (excluding pensions, rental income and so on) will also pay the new levy, though only the 1.25pc surcharge, not the full NI whack. Though technically not National Insurance, this will mark the first time those in receipt of the state pension have made a contribution towards benefits via a levy.
When NI was introduced in 1911 far fewer people lived much beyond the state pension age. Today the opposite is true, and tax experts have been pointing out for years how pensioners’ exemption from NI is baffling when you consider the enormous cost of the state pension, which works on a pay-as-you-go basis, with younger workers paying today’s pensions.
So why was the 1.25pc figure chosen? Presumably it was the result of a tussle between the Prime Minister and Rishi Sunak, the Chancellor. More strange is that the same figure has also been used to increase taxes on dividends, adding yet more muddle.
Shareholders already pay tax on company payouts at a rate determined by their income tax bracket less a £2,000 annual allowance. Now investors have to contend with rates to two decimal places. It’s almost like someone at the Treasury saw the social care levy at five minutes to midnight before the announcement and suggested tacking the same figure on to dividends too, surmising (correctly) that no one would understand it anyway.
Politicians claim to want to simplify the system but there is little incentive to do so. When he set up the OTS in 2010, the then chancellor George Osborne pinned the blame on Tony Blair’s administration, for taking a “complex tax system and making it worse”.
He was quite right to say that a decade of “meddling and intervening” had turned the tax affairs of millions of families into a “mess”. He had six years to turn it around but instead made it a whole lot worse.
Mr Osborne clearly realised that complexity is pretty handy when you want to raise cash without people noticing. The interaction of those four income taxes combined with the means-testing of various allowances creates an array of different marginal rates far higher than the official 45pc top rate of tax.
Well over 300,000 people effectively pay income tax at 60pc, for instance. This quirk is caused by the removal of the personal allowance, the amount you can earn tax-free, once you earn more than £100,000. For every £1 earned over £100,000, the allowance drops by 50p. The result is that each additional £1 of income effectively incurs 60p of income tax. Once National Insurance is factored in, the true rate is even higher.
The same thing occurs with the withdrawal of child benefit when one parent earns more than £50,000. The benefit is clawed back via tax charges until it is entirely wiped out once income tops £60,000. Again the result is that on that portion of income the effective tax rate is 60pc. Most bizarre of all is the marriage allowance, a perk afforded only to couples with one non-taxpayer and one basic-rate payer. As soon as one partner’s income breaches the higher-rate threshold, now £50,271, the couple lose the tax break entirely. That means £1 of income costs £252.
Aside from giving everyone a migraine, there are serious consequences of such a convoluted system. Firstly, the public don’t fully understand how the Government is milking them, and so are powerless to fight back. There is an economic cost, too. Individuals are forced to pay ever growing sums to tax advisers to help them comply with the rulebook, now far north of 10 million words long, 48 times the length of Hong Kong’s tax code. Investment is also hampered, as foreign firms spend gargantuan sums navigating corporate tax law or give up.
What to do? There’s no silver bullet to a muddle of this complexity but one place to start would be to make it a statutory duty of ministers to follow the OTS’s advice or explain why they refuse. The OTS was a great idea; we just need to give it some clout.
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