Social Progress Party
Politics to serve all of society, not just the wealthy and powerful.
Problems with Income Tax and National Insurance Contributions
IT Rates & NICs are currently illogically applied and deceptively presented, with three major areas that should be simplified and clarified.
The chart above shows how the tax rate applied to each individual pound of income changes as you progress through the Personal Allowance, Basic, Higher and Additional Rate bands.
Between £100k and £125k the effective total paid is 62p of every £1, after £125k, only 47p of each pound is paid.
1. Additional income tax rate
There is a hidden tax band, with an effective rate of 62% on every pound earned between £100,000 and £125,140, through the loss of 50p of tax-free allowance for every additional £1 earned. This rate then drops to just 47% thereafter as the tax-free allowance is completely removed, but the 45% Additional Rate is applied. This is illustrated in the chart on the left.
While £100,000 is a high income, this makes salary increases in this bracket less rewarding, and creates an artificial incentive for employees to seek larger increases than they would otherwise want in order to offset the tax impact. It also adds complications in the application and calculation of taxes and serves no purpose other than to satisfy philosophical objections to offering a tax-free allowance to higher earners and to disguise the introduction of an additional tax band. Why not retain the allowance and simply introduce an additional rate?
It also means that Additional Rate payers pay less tax on each pound earned above £125,140 than they do on each pound earned between £100,000 and £125,140. What rationale is there for higher earners to pay a lower rate than people paid less than them?
2. Smoothing impact of NICs
When you look at the impact of NICs on the total tax charged on income, this has a smoothing effect that is not well understood, meaning that the increase in income tax rates when moving from the Basic to the Higher rate is partially offset.
Many people assume that because there are four tax rates (0%, 20%, 40% and 45%), that the Higher and Additional rate payers must pay an additional 20% or 25% compared to Basic rate payers, but the differences are actually only 14% and 19%, as NICs drop from 8% to 2% at the threshold for the Higher rate (currently £50,270).
There is a legacy rationale for this 6% drop in NICs. Since NICs were directly linked to pensions, and the state pension has a capped maximum, it was deemed unfair for higher earners to pay more when their related benefit is capped. Indeed, the 2% charge maintained for Higher and Additional Rate payers has only been collected since 2011, prior to that it was 1%, and up until 2003 there was no NICs at all for income above the Basic Rate.
Since NICs have effectively become a general tax, with no direct link between them and pensions (as shown by pension age reform, and by the introduction of the maintained charge for Higher Rate payers in 2003), it is not a rationale that should be applied any more.
The chart above shows the cumulative combined income tax & NICs rate paid as income increases (total paid divided by total income).
There are very few accelerated areas and the curve of the plotted line flattens out quite quickly as income increases. You can see that at £200k income, the overall rate paid is only just over 40%, much less than the 45% people might assume for this level of income (and even less than the 47% you would expect for IT plus NICs).
3. The weakening of the link between increased income and increased tax rates after £125k.
The Cumulative Tax Rate chart shows the current cumulative tax rates for incomes from nil to £200,000.
You will notice that the rate increases at a fairly consistent rate up to £125k, however the increase slows after that, with a £200k income paying an additional 3.5% compared to £125k income (an incremental 0.05% per extra £1,000), when someone at £125k pays 6.4% more than someone at £100k (an incremental 0.26% per extra £1,000).
The SPP agrees that there should be a cap to the level of Income Tax and NICs paid, however we believe that the incremental nature of the cumulative rate should continue far further than the current limit, as well as ultimately reaching a higher maximum rate.
This could be arranged in such a way as to slightly reduce the tax collection from Basic and Higher Rate incomes, whilst increasing overall receipts through collecting more from Additional Rate earners.