An increase in the higher rate of income tax to 45% on incomes above £80,000, and a 50% rate on incomes above around £125,000, could raise up to £2bn in additional tax revenues, according to analysis by the Institute for Fiscal Studies (IFS)
Any rise in income tax would disproportionately hit those earning up to £200,000, rather than high net worth, high income individuals who are more likely to use sophisticated tax planning to mitigate any rise in income tax rates.
Analysis by the IFS drills down into the impact of any hike in income tax rates, with signs that owner managers and the self employed are the most responsive to tax hikes. The report states that ‘company owner-managers and the self-employed are particularly responsive to taxes, reflecting their greater scope for income manipulation, tax planning and evasion. Interestingly, we show that in recent years company owner-managers have been much more responsive than the self-employed’.
However, most taxpayers are employees paid through PAYE and they have limited ability to manipulate their incomes and are subject to third-party reporting.
The analysis found little impact of the tax changes on the top 1% of earners. The IFS paper stated that ‘this may also reflect other changes in the tax system and/or the type of income earned by high income individuals. Increased use of corporate structures following reductions in corporation tax… has also meant that there is increased scope for high-income individuals to shift their income between different time periods using retained corporate earnings in order to minimise their tax liabilities’.
The Labour manifesto at the 2017 election proposed a 45% tax rate that would raise up to £4.5bn in additional tax, which the IFS considered a ‘little on the high side’. This reflected a high degree of uncertainty about the extent to which taxpayers would respond if their tax rate was increased, and the importance of such responses to the revenue effects of Labour’s proposals.
The current 40% higher rate income tax kicks in at £45,000 with the current government planning to raise this to £50,000 by the end of this parliament, if not earlier. For income over £100,000 to £123,000 the personal allowance decreases from £11,500 by £1 for every £2 earned, until it reaches zero. This creates a painful pinch point for higher rate taxpayers.
Income tax bands of taxable income (£ per year) (personal allowance £11,500 17/18)
| Tax year 2016-17 | Tax year 2017-18 |
|---|---|---|
Basic rate | £0-32,000 | £0-33,500 |
Higher rate | £32,001-150,000 | £33,500-150,000 |
Additional rate | Over £150,000 | Over £150,000 |
Source: HMRC
In its latest IFS Briefing Note the IFS analyses how high income taxpayers respond to changes in income tax rates, focusing on most responsive groups of taxpayers, and the impact of various tax changes on behaviour.
IFS analysis also shows that a tax policy based on a higher rate escalator, as proposed by Labour, could raise £1-2bn a year in revenues, but it would be affected by a range of factors, not least efforts by taxpayers to bring forward income to avoid the pre-announced tax rise by ‘forestalling’.
This was the case in 2010, when the marginal rate of income tax on incomes above £150,000 was increased from 40% to 50% when the coalition government came to power. It was then cut to 45% in 2013, after HMRC estimated that the 50% rate would probably raise no more than a 45% rate, as individuals responded to the higher rate by reducing their taxable income.
50% rate hits earners up to £200k
The latest IFS research finds evidence that the overall high degree of responsiveness of high earners to the former 50% rate was driven by those with the very highest incomes: those with incomes between £150,000 and £200,000 appear to be only a third to a half as responsive to tax rates as the £150,000+ group as a whole.
Furthermore, the estimates suggest that this additional revenue would likely have come predominantly from those with incomes between £80,000 and £200,000, rather than those with the very highest incomes.
Individuals with dividend incomes, such as owner-managers of incorporated businesses, are more responsive to changes in tax rates than those with employment income. Incomes from this source jumped substantially in 2009–10 (prior to the introduction of the former 50% tax rate), fell substantially in 2010–11 (after the introduction of the 50% tax rate), and remained relatively depressed the following year.
This reflects the fact that company owner-managers can manipulate the timing of their income by retaining it in or taking it out of their company at a time that lowers their overall tax bills: such as bringing it forward to avoid the 50% tax rate. In addition they can manage their earnings through the use of dividends although the government has eroded this benefit over the last two Budgets, introducing the £4,000 dividend allowance.
Figure 1. Trends in different income sources and deductions for groups with incomes greater than £150,000, 2001–02 to 2011–12
Note: Blue vertical line shows when the 50% tax was announced (in March 2009) and the red line when it was implemented (in 2010–11). Source: IFS - authors’ calculations using SA302 data from 2001–02 to 2011–12
The cost of deductions reported on tax returns fell when the 50% tax rate was introduced.
The IFS Briefing Note (BN214) Estimating the responsiveness of top incomes to tax is available here https://www.ifs.org.uk/publications/9675
IFS Working Paper (W17/12) Updating and critiquing HMRC’s analysis of the UK’s 50% top marginal rate of tax and the revenue effects of the UK’s short-lived 50% income tax rate on incomes above £150,000 (April 2010 to March 2013).
IFS Working Paper (W17/14) Frictions and taxpayer responses: evidence from bunching at personal tax thresholds looks at how taxpayers respond to income tax thresholds where marginal rates change (such as the higher rate threshold where the rate increases to 40%, and £100,000, where personal allowance is tapered away, creating a 60% marginal rate).