Our "shockingly high" tax regime

 Matthew Lynn

City columnist

Britain’s shockingly high tax burden

The higher rate was once for fat cats. Now, more and more of us end up paying it. That will stifle growth

You need to have been following Budget speeches for a long time to remember when the 40% top rate of tax was introduced.  It made its debut on 15 March 1988, when Margaret Thatcher’s chancellor Nigel Lawson embarked on a far-reaching reform of the tax system. The basic rate of tax was reduced from 27% to 25%, corporation and inheritance taxes were reformed and, most radically, not to say controversially, the top rate was sliced from 60% to just 40%. It was designed to be a top rate of tax that would only be paid by a small fraction of the workforce and even then would not take such a high share of their income as to deter them from working. By 1990, only  1.7 million people were paying the 40% rate. By the time Tony Blair became prime minister that total had risen to 2.1 million and by 2010 it was 3.3 million. 

Ever since then, however, the numbers have started to explode. By 2019 the total was up to 4.3 million, and in the current tax year it will be up to six million. Simply freezing the thresholds, as Rishi Sunak did as chancellor, combined with inflation running at more than 10% a year, has pushed more and more people into the top bracket. Now, Sunak’s chancellor, Jeremy Hunt, has frozen the thresholds all over again, a move that will take at least another two million people into the bracket by 2028, making a total of eight million, or more then five times the number when it was introduced. 

ADD IN THE “GRADUATE TAX”

The reality is even worse than it sounds. The workforce is shrinking rapidly – more than a million people have left it since the pandemic. It is likely that the bulk of those are concentrated at the lower end of the wage scale, for the simple reason that anyone earning a big salary is a lot more likely to be doing a job they enjoy and that they find rewarding. As more and more low earners leave the workforce, discouraged by poor earnings and higher taxes, the percentage of top-rate payers in the overall workforce will inevitably rise. 

And, as columnists at Bloomberg argued last week, we should also take into account student-loan repayments, which are effectively a graduate tax. Ever since fees went up to £9,000 a year at the start of the last decade, most students are now emerging with £50,000 of debt, or often more. With the “graduate tax” kicking in at 9% even on a fairly modest income of £30,000 a year, that has to be added in to get a sense of what the marginal tax rate actually is. Add in national insurance and the loan repayment, and anyone on that income with a degree will actually be paying 40% tax long before they reach the actual threshold for the higher rate (and they will be paying a shocking 70% at higher incomes, but that is a different story). In other words, far more people are paying the higher rate than the official figures suggest, and the numbers will be rising all the time as more and more graduates with higher debts enter the labour market. 

THE NEW STANDARD RATE

Add it all up and up to half of the workforce of 31 million and perhaps more could end up paying the top rate. In reality, 40% will not be a top rate anymore. It won’t even be a higher rate. It will be the new standard rate. On current trends, within a few years there will be a 20% rate for low earners, a standard 40% rate for most of us, and a  top 45% rate (although in reality probably  a 50% rate by then) for the wealthy. Without any real discussion, and without anyone pausing to ask whether that is healthy for the economy, that is where we are inevitably heading. 

This is scandalous. A 40% standard rate of income tax is ridiculously high, especially when people are paying 20% VAT on anything they buy, on top of fuel duty, stamp duty, inheritance tax, and all the other levies the state imposes. As Nigel Lawson realised, the key to unlocking greater enterprise and improving incentives is to leave more money in people’s pockets. A rate that takes almost half a person’s income will for most be a crushing burden that will squeeze the life out of the economy.