Daniel Patterson is a technology consultant.
There is one policy change that would have improved the recent Budget: the restoration of the Personal Allowance for incomes above £100,000. This change is easy to implement, would generate revenue, and would boost economic growth.
Currently, the first £12,570 of income is tax-free with any additional earnings subject to the basic rate of income tax (20 per cent) on income up to £50,271 and a higher rate (40 per cent per cent beyond this point. However, this allowance begins to taper off at £100,000, so that for every additional £2 earned, £1 of the personal allowance is withdrawn. This means that the tax-free allowance is removed altogether once your income hits £125,140.
The income tax rate effectively becomes 60 per cent between £100,000 and £125,140 due to this personal allowance taper. With two per cent in national insurance contributions to pay as well, this taper results in an extremely high marginal tax rate for those in this income bracket.
Many people have additional circumstances that take this rate even higher, such as student loan repayments (nine per cent) and pension contributions (at least five per cent). It is anticipated that by 2028 as many as two million people will fall into this 60% tax trap.
All of this is to say that, for every extra pound people in this tax bracket earn, they might take home less than 30p. The reality is that once you break six figures, any increase in pay has to be substantial for you to feel any better off. This has serious implications for the economy.
Losing such a large share of your income to taxes creates a psychological barrier that acts as a deterrent to effort and enterprise. The Centre for Policy Studies has long called for a “work guarantee” where the Government does not take more than half of every extra pound someone earns. This idea is backed by 61 per cent of the British public.
Anomalies such as the personal allowance taper violate this principle, so incentives are distorted and it does not pay to work more. Faced with such a high marginal tax rate, people assess their circumstances and many opt to keep their incomes below £100,000; depriving Britain of the chance to create even higher earners who would contribute more in taxes and boost our economy.
As workers approach this point on the income scale, they begin to think twice about pursuing promotions or chasing bigger bonuses. Many conclude that the additional responsibility and time commitments that come with career advancement are simply not worth the nominal increase in take-home pay. Others decide it is better to reduce their hours by moving to a four-day week. Often people will divert income over £100,000 into their pension funds where contributions are tax-free, thereby taking money out of the economy. While pensions will benefit earners in the long term, these people will feel no better off in the short term.
It is common for any suggestions of tax cuts to be met with questions of how much they will “cost” and how they will be “funded”. This view is misguided because it assumes all money belongs to the state rather than the people who earn it. However, if we are to entertain this argument, then scrapping the personal allowance taper is one of the best tax cuts the government could deliver because it would give people an immediate incentive to exceed the £100,000 barrier. At present, people deliberately suppress their earnings so the amount of tax revenue the government collects on income between £100,000 and £125,140 is lower than it would otherwise be.
Removing this barrier to growth would allow people to keep (and spend) their money rather than maximising their pension allowances. It is also a very easy change for the government to implement given that the status quo is unnecessarily complex. The personal allowance taper is difficult for employers to administer so even salaried employees who are taxed as they earn end up having to submit self-assessment returns.
Some will argue that now is not the time to prioritise tax cuts for the top three per cent of earners. Yet these are the people who contribute the most and ultimately fund public services. It is in everyone’s interest that these people pay more tax — not through higher rates, but through the opportunity to earn more. It makes more sense for them to earn and pay more than to suppress their incomes and have the country lose out on additional revenue.
It should concern us all that people with in-demand skills and money to invest are choosing to leave Britain or not come here at all. Other countries recognise that they must compete for business and talent and are tailoring their tax systems accordingly. Britain cannot afford to be viewed as a hostile environment for aspiration and wealth. If Jeremy Hunt is serious about “fostering the animal spirits that spur economic growth”, he should start by restoring the personal allowance for everyone.