Lord Lawson, left, is urging chancellor George Osborne to use his first purely Tory Budget to cut the top rate of income tax
Lord Lawson, left, is urging chancellor George Osborne to use his first purely Tory Budget to cut the top rate of income tax

Former Conservative chancellor Lord Lawson on Wednesday night urged George Osborne to cut the top income tax rate to 40p in next month’s Budget, amid signs the Treasury is considering such a move.

Mr Osborne plans to use his Budget — his first as chancellor of a purely Tory government — to make radical shifts towards what David Cameron has called a “lower tax, lower welfare” economy.

The chancellor has indicated in Treasury meetings that he might cut the 45p tax rate on earnings above £150,000, fulfilling a goal that the Liberal Democrats blocked him achieving in the coalition.

Lord Lawson, a confidant of the chancellor, told the Financial Times: “I would strongly support this: It would significantly enhance the attractiveness of the UK as a place to do business, at no cost in terms of lost revenue.

“That was the experience when I brought the top rate down to 40 per cent in 1988 and it is even more relevant today.”

Mr Osborne knows the move would carry a political risk, since Labour would accuse him of cutting taxes on the wealthiest while cutting £12bn in tax credits and other benefits paid to the poor.

But the chancellor would be cheered by Conservative MPs and the move would be welcomed in the City of London, where banks have complained that his tax and regulatory regime has become too onerous.

With a majority of 12, Mr Osborne knows that there is unlikely to be a better time to cut the top rate of tax. Labour increased the rate from 40p to 50p in 2009 after the financial crash: Mr Osborne cut it to 45p in his 2012 Budget.

He could present the cut, which would cost about £900m according to the Treasury’s “ready reckoner”, as part of a package of measures that would bear heavily on the rich.

The Conservatives have promised to cut pension tax relief on the highest earners, while Mr Osborne is also expected to announce a £5bn crackdown on tax avoidance.

He will also use the Budget to raise the income tax threshold for those on low earnings and to make progress towards a £50,000 starting rate for the current 40p rate.

The Treasury declined to comment on “Budget speculation” but Mr Osborne and his team plan to use the occasion to show what a “true Conservative Budget” will look like.

The chancellor was careful before the election not to exclude a cut in the top rate of tax to 40 per cent, saying only it was not part of his “plan”.

Curbs on pension tax relief for top earners could potentially raise significantly more than the £1bn needed to fund the Tory’s manifesto pledge to create a £1m inheritance tax threshold.

Economists said it was unclear whether even more drastic cuts to top earners’ pension tax relief could also cover the cost of reducing the top tax rate to 40p.

The cost of pension relief for top earners runs into billion of pounds. A 2013 analysis by Pensions Policy Institute, a think-tank, said a fifth of all pension net tax relief went to people earning more than £150,000 but subsequent cuts in the annual allowance may have lowered that proportion. Gross pension tax relief in 2013-14 was estimated at £34.3bn but the net cost was £22bn after taking account of tax received on pensions being paid.

But the Treasury would be unlikely to be able to abolish all pension relief for top earners. Its withdrawal would have to be phased in to avoid creating a cliff edge with an extremely high marginal rate at £150,000.

Before the election, the Conservatives announced plans to raise £1.4bn by cutting the annual allowance, the amount that can attract income tax relief in any year, from £40,000 to £10,000 once income reaches £210,000. The extra revenue raised if the Treasury decided to cut the annual allowance to zero would be likely to be substantial but would depend on the distribution of incomes and pension contributions above £150,000.

HM Revenue & Customs estimates suggest that there were 313,000 additional rate taxpayers in 2014-15 — roughly the top 1 per cent of all taxpayers. They earned an estimated 12.5 per cent of all reported income and were expected to pay 27.3 per cent of all income tax revenue.

When former Labour chancellor Alistair Darling announced plans to introduce a 50p income tax rate for those with incomes above £150,000 from 2010-11, it was originally estimated to increase tax revenues by £2.7 billion a year. But Mr Osborne commissioned HMRC to analyse the 2010-11 tax returns to assess how much extra tax had actually been raised. It estimated that the 50p rate brought in £1bn more than the 40p rate. Cutting the rate back to 45p was estimated to cost £100m, suggesting that reducing it to 40p would cost at least £900m.

Stuart Adam of the Institute for Fiscal Studies think-tank said cuts in pension tax relief would not lead to a permanent rise in revenues and restricting relief for those earning more than £150,000 lacked an underlying justification.

The estimates of the cost of reducing the top tax rate are subject to large margins of errors. There is also uncertainty about the revenue raising potential of more curbs on pension tax relief, as the amount it would raise in the long run will depend on how people respond.

The article has been amended to correct the estimated cost of reducing the top tax rate to 40 per cent.

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