Pickpockets at the Treasury ?

When the Chancellor announced his budget measures last month, much was made of the increases in Corporation Tax and the maintenance of the headline rates of Income Tax and National Insurance. However, little was said about the freezing of the personal tax allowances and tax thresholds other than to describe it in some quarters as a “stealth tax”

So what exactly is a stealth tax and how does it differ from the taxes that we all know about and would love to avoid ? 

In the UK tax system, the Personal Allowance is an amount every taxpayer is allowed to earn before having to pay any income tax. It currently stands at £12,500 per annum. Thereafter, the rate of income tax you pay depends upon the amount you earn. For the current tax year, the next £37,500 of income is taxed at 20% whilst the £100,000 of income after that is taxed at 40%. Any income above that is liable to tax at 45%. 

Taxpayers Pay More Without Realising it

Historically, earnings have tended to rise broadly in line with inflation so that taxpayers spending power maintains parity with the economy as a whole. In recent years, Government policy has also tended to ensure that the amount of tax an individual pays reflects inflationary changes by moving the tax free amounts and tax bands in line with inflation. An example will perhaps best illustrate this. 

In the example above, as the taxpayers income increases in line with inflation by 3% per annum, the change in tax bands by the same 3% per annum means that the average tax rate stays at a constant 6% across the 5 years we are looking at. 

Now consider what happens if the tax bands are not inflated 

In this case, as the tax payers income increases in line with inflation, more of it now gets taxed because the tax free amount has not changed. As a result, the average amount of tax suffered by the taxpayer progressively increases from 6% in 2021/22 to 7.6% in 2025/26. That’s an extra £777 in tax paid – or an increase of 13.6% in what they might otherwise have paid. However, as neither the rate of tax nor the allowances are changing, the overwhelming majority of taxpayers don’t notice the tax increase – which is why it is termed a “stealth tax”. 

A Regressive Tax Measure

Depending on what a taxpayers total income is, the impact on net earnings after tax can be very significant indeed. The table below illustrates the impact of the change in taxpayers net income tax paid (all other things being equal) at the end of five years

The largest impacts will be felt by those whose income is close to the margins of a tax band. For the lower paid, many will be required to either pay tax for the first time or else see a larger proportion of their income taxed – hence the increases in tax are large. Similarly, for those whose income hovers around £50k per annum, they will either start paying higher rate tax at 40% for the first time or else see a larger proportion of their income taxed at the higher rate. In that sense at least therefore, the measure is regressive inasmuch as it affects taxpayers lower down the income scale more than those higher up the scale. 

So What Does the Treasury Get out of it ?

According to the Office of Budget Responsibility, the freezing of tax allowances will draw an extra 1.3 million taxpayers into paying tax for the first time and will also result in an extra 1.0 million taxpayers paying higher rate tax. The total amount of extra tax raised will as a result be around £8 billion by 2025/26 which equates to around 1% of the UK’s total annual expenditure pre Covid. 

So the next time you hear a politician telling you tax rates haven’t changed, you’ll know the real answer !

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