Living with fiscal drag
Tax impact on higher earners
A wide range of tax measures – including some welcome tax cuts – featured in November’s Autumn Statement, but they did nothing to reduce fiscal drag. Higher earners have lost reliefs and allowances at certain income levels, and are left unduly penalised for any extra income they earn.
The High Income Child Benefit Charge starts to claw back child benefit when income exceeds £50,000, with this threshold not changing since its introduction in 2013.
Zoe, who claims child benefit for four children, currently earns £50,000, but will receive a £5,000 pay increase for 2024/25. Tax and NICs on the pay increase are bad enough at £2,068, with the frozen basic rate tax threshold meaning 40% tax is paid on most of the increase. However, Zoe will also lose £1,987 in child benefit, so will keep just £945 of the extra income of £5,000.
It is generally understood that a marginal income tax rate of 60% kicks in on income between £100,000 and £125,140 due to the tapering of the personal allowance. The £100,000 income limit is unchanged since withdrawal was introduced in 2010. However, many may not be aware that government-funded childcare entitlement in England ceases to be available at the same £100,000 threshold.
Daniel currently earns £100,000 and claims free childcare worth £12,800 for his two three-year old children. He has been offered new employment at a salary of £120,000. Tax and NICs on the £20,000 additional earnings will be £12,400, leaving £7,600. This is way less than the value of the lost childcare, so Daniel might need to consider postponing the move until his children are at school.
Higher earners who have been hit by fiscal drag can avoid high marginal tax rates by paying more into their pensions. Both Zoe and Daniel could remove all of the negative impacts from receiving their extra income by making gross pension contributions of £5,000 and £20,000 respectively, with Daniel even retaining his free childcare.
However, other taxpayers, especially younger ones, are often unable to do this because their living costs are too high to even consider making additional pension payments.
The overall impact of fiscal drag can be seen in the government’s soaring tax take. For the six-month period to November 2023, the amount of income tax, capital gains tax (CGT) and NICs collected was over £280 billion. Compared with the corresponding period a year ago, this is an increase of more than £12 billion.
What might surprise you is that around a quarter of the tax take is paid by just 100,000 taxpayers. Their average income tax and CGT bill for 2021/22 was nearly £560,000, with this average amount increasing by £84,000 compared with the previous year.
The additional rate tax entry point was reduced to £125,140 from April 2023, so the share of tax paid by the wealthiest is only likely to increase.
The wealthiest individuals are the most able to leave the UK or they may choose to reduce the time spent here in order to become non-UK resident. The impact of the top 1,000 taxpayers escaping the UK tax net would be a loss of £11.5 billion in taxes for the public coffers.
Please get in touch if you find you are a victim of fiscal drag.