40 per cent tax to hit more middle-income taxpayers

Hundreds of thousands more taxpayers could be drawn into the 40 per cent income tax band over the next few years, accountants say, following a freeze on the
higher-rate threshold and personal allowances in Alistair Darling’s pre-Budget report (PBR) this week.

Employees and the self-employed – though not pensioners or buy-to-let landlords – are also set to pay an extra one percentage point in national insurance contributions (NICs) from 2011.

While the chancellor did not announce any change to headline rates of income tax this week, millions of individuals face increases in tax and NICs of hundreds of pounds a year, according to tax advisers.

Richard Proctor, partner at accountancy firm Grant Thornton said: “Clearly, the burden of the government’s deficit-reduction programme is going to fall heavily on ordinary taxpayers, as well as on the wealthy.”

Personal allowances and income tax thresholds will not, unusually, be increased for the next tax year starting in April 2010. The chancellor also said he planned to freeze the point at which individuals start paying 40 per cent tax – currently £43,875 – in 2012-13.

This means that people whose incomes rise will be taxed more heavily. More will be pulled into higher tax bands, while those already paying 40 per cent will pay higher average rates on their overall income, accountants say.

This so-called fiscal drag – in which tax bands fail to keep pace with earnings growth – has already seen the number of higher-rate taxpayers soar to about 3m since 1997, and accountants say that freezing tax thresholds will fuel this trend.

Even basic-rate taxpayers who receive a bonus could be tipped into the unchanged 40 per cent band, said Nicola Roberts, tax director at accountancy firm Deloitte.

Mike Warburton, senior partner at Grant Thornton, added: “These are tax rises without the general public realising it – it’s the old stealth tax story.” He suggested that the £43,875 at which taxpayers generally start paying 40 per cent tax could remain frozen for the next three years, potentially pulling in another 500,000 individuals to the higher-rate band. The unchanged threshold could cost higher-rate taxpayers an extra £1bn overall, he said.

NIC rates are due to increase by one percentage point from 2011 – to 12 per cent for earnings up to about £44,000, and to 2 per cent for higher earnings. The increase includes the 0.5 percentage point that Mr Darling announced this week and a similar
rise unveiled in last year’s PBR.

The chancellor said those earning less than £20,000 would be spared higher bills, because the lower threshold at which NICs have to be paid will be raised to about £7,000.

For working people in most income bands, the increase will cost hundreds of pounds. However, pensioners as well as others living off “unearned” income – including investments and rental income – are not subject to NICs, and therefore will not be affected.

People on incomes over £100,000 already face higher tax bills from April 2010 as
a result of the previously announced clawback of their £6,475 personal allowances.

Additionally, those earning over £150,000 will be hit by the introduction of the new 50 per cent top rate of income tax.

With the increase in NICs, from 2011, the top combined rate of income tax and NICs will be 52 per cent (see graph above), while those earning between £100,000 and £112,950 face effective tax rates as high as 62 per cent because of the tapered withdrawal of personal allowances between these income levels.