ICAEW chart of the week: personal tax bands

This week’s chart examines the complexity in the tax system and potential options for reform by looking at the number of tax bands for salaried employees across the UK.

Chart showing personal tax bands from £150,000 (45% UK income tax +1% Scottish income tax + 2% Employee national insurance) down to £0.

See text for more details.

The new tax year saw the introduction of an additional tax band to the UK system of personal taxation, bringing the total number to nine tax bands in England, Wales and Northern Ireland and twelve in Scotland.

The #icaewchartoftheweek continues on the theme of complexity in the tax system and potential options for tax reform by looking at the number of tax bands for salaried employees, with up to nine tax bands in England, Wales and Northern Ireland and up to twelve in Scotland.

Although the advertised personal tax allowance of £12,570 a year suggests that individuals only start to pay tax above that point, in practice ‘taxation’ in its wider sense can start from as little as £0, which is when some of those claiming universal credit start to have their benefits withdrawn at a rate of 63p in the pound. The threshold is £0 for those without dependent children, £3,516 for those on housing benefit and with dependent children or limited capability to work, or £6,180 for those with dependent children or limited capability to work who are not on housing benefit. The rate of withdrawal is even higher for those receiving council tax benefit, with an additional 20% or more levied on incomes above a certain level until it is fully clawed back – the details vary by council.

Tax in its more formal sense starts at £9,568 when employee national insurance of 12% starts to be levied. Although ‘constitutionally’ different in how the money collected is used and its role in entitlement to the state pension, in substance it operates as an income tax in all but name.

Income tax itself starts to be levied on earnings above £12,570 at a basic rate of 20%, adding to national insurance to give a marginal tax rate of 32% for those not on universal credit and 74.8% for those who are.

For those in England, Wales and Northern Ireland this tax band goes from £12,570 up to £50,000 but in Scotland, there are intermediate tax bands, with a lower rate of income tax of 19% between £12,570 and £14,667, 20% between £14,667 and £25,926, 21% between £25,926 and £43,662, and 41% above £43,662 when the higher rate of Scottish income tax kicks in.

The new tax band this year arises because the government failed to increase the £50,000 threshold at which child benefit is withdrawn from the higher-earning parent to align with the increase in the higher rate tax threshold to £50,270. This means the insertion of a new tax band between £50,000 and £50,270 as the government starts to withdraw entitlement to ‘universal’ child benefit of £21.15 a week for the eldest child and £14.00 a week for remaining children by collecting an additional tax of 11% for the eldest child and 7.3% for the second and each of any subsequent children.

Above £50,270, the higher rate of income tax of 40% starts to be levied in England, Wales and Northern Ireland, but the marginal rate of national insurance reduces to 2% meaning that this is a 10% increase from 32% to 42% in the combined marginal rate – at least assuming you don’t have children! This rate also applies to those with children from £60,000 up until £100,000 when the marginal rate jumps to 62% (63% in Scotland) as the personal income tax allowance is gradually withdrawn. The marginal rate reverts to 42% (43%) from £125,140 before increasing to 47% (48%) for those on the 45% top rate of income tax above £150,000.

While devolution has led to some of the complexity, this probably hasn’t been helped by the perennial tendency of governments to find ever more complicated approaches to extract additional money from taxpayers without touching the headline rates of tax – for example through the ‘withdrawal’ of the personal tax allowance, which in substance operates as an additional 20% tax payable by those earning between £100,000 and £125,140.

The consequence of this tinkering with the tax systems means there are now nine different tax bands in England, Wales and Northern Ireland with marginal tax rates of 0%, 12%, 32%, 32% + 11% (or more) for higher-earning parents, 42% + 11% (or more) for higher-earning parents, 42%, 62%, 42% and 47%. In Scotland there are twelve: 0%, 12%, 31%, 32%, 33%, 53%, 53% + 11% (or more) for higher earning parents, 43% + 11% (or more) for higher earnings parents, 43%, 63%, 43% and 48%. 

Such a complex system invites the question of how it might be reformed, with the possibility of increasing the national insurance threshold to align with the income tax personal allowance being actively discussed in recent years to eliminate one of the bands. However, this now seems less likely than it once did since the pandemic caused such damage to the public finances. Other ideas have included aligning the 40% higher rate and 45% top rate of income tax (either up or down depending on political preference) or ‘folding’ in the personal tax allowance withdrawal into the tax system as part of the higher or top tax rates in conjunction with a reform to tax thresholds.

However, another option would be to add even more complexity, a real possibility now the Welsh government has obtained devolved powers to adjust its income tax rates and thresholds like Scotland, albeit powers that have thankfully not been used so far.

Either way, the nirvana that some tax reformers aspire to of a single flat rate of income tax applying to all earnings seems more remote than ever. One can but dream!

This chart was originally published by ICAEW.

ICAEW chart of the week: personal taxation by legal form

ICAEW’s chart this week compares the differences in the tax payable depending on legal form – an area ripe for reform in theory, but much more difficult in practice.

Chart showing tax payable on £80,000 of business earnings:

Employee - income tax: 20.0%, employee NI 6.6%, employer NI 10.7% - take home pay 62.7%.

Self-employed - income tax: 24.3%, employee NI 5.5% - take home pay 70.2%.

Company owner - income tax 9.9%, corporation tax 16.9% - take home pay 73.2%.

Comments by the Chancellor last year suggested he might tackle one of the thorniest challenges in the UK tax system – the differences in tax paid by individuals depending on the legal form through which they conduct their business activities. However, as the controversy over IR35 has demonstrated, a significant amount of political capital is likely to be needed if changes are to be made.

The #icaewchartoftheweek provides an illustrative example of just how significant the differences can be, with £80,000 in business earnings attracting an effective tax rate of 37.3% if paid to an employee on a salary of £71,460, 29.8% if paid to an individual who is self-employed or in a partnership, or 26.8% if earned through a company and distributed as dividends. 

(It is important to note that this is a theoretical illustrative example for a single person with no other earnings and not paying any pension contributions, with the company owner in the example paying a salary equivalent to the secondary threshold for national insurance before paying the rest as dividends. Actual amounts of tax paid will of course depend on both business and individual circumstances, which can vary significantly.)

The last decade or so has seen a significant increase in the numbers of people becoming self-employed or conducting business through their own companies, and the tax authorities have been concerned about the loss in tax that has followed. One way they have sought to tackle this is by removing the tax benefits of being self-employed or operating through a company from some people, which is the approach adopted by IR35. Coming into force this month, IR35 in effect creates a new legal status of ‘deemed employee’ for tax purposes, reclassifying individuals back into the scope of employment taxes. This has proved highly controversial, accompanied as it is by extensive compliance requirements and general unhappiness by those determined to be subject to it.

Another potential approach would be to change the taxes and tax rates applying to three different forms – either by reducing the taxes on employees or by increasing them on the self-employed or those operating through companies. The former seems unlikely given the state of the public finances, but the challenge in increasing rates can be extremely politically difficult, as former Chancellor Philip Hammond found a few years ago when he proposed a relatively modest increase in the amount of national insurance to be paid by the self-employed.

Whether current Chancellor of the Exchequer Rishi Sunak will take forward a suggestion he made last year when he announced the self-employed income support scheme last year that taxes on the self-employed might rise is yet to be seen. However, what is likely is that this and future Chancellors will continue to look at this particular aspect of the tax system and wonder how they might collect a little more from the ranks of the self-employed and company owners. 

This chart was originally published by ICAEW.