The introduction of the 50% top rate of tax, and the 60% ‘stealth tax’ that arises as a result of the reducing allowance on earnings over £100,000, have made many more highly paid people sit up and take notice of tax avoidance. That’s impacted negatively on tax receipts, which wasn’t the original intention of an increase in the tax rate, and is not good for the economy.
The Public Sector Finances for January show that tax receipts in January, the first collection period after the top rate was introduced in the 2010/2011 financial year, fell by £509m, or 4.7%. You might think that the economic malaise is to blame, but in the same period income tax receipts under Pay As You Earn (PAYE) rose by 2.3%.
So, why is it that those who largely can’t control how they pay tax, mostly employees, have paid more, whereas those who largely can control how they pay tax, mostly business owners and contractors, have paid less?
Granted, this is a simplistic view, as is drawing too many conclusions from the fall in self-assessment receipts in the first place, because it only represents the first period of collection. But anecdotal evidence suggests that taxpayers who were prepared to pay 40% of their earnings to the state have balked at paying 50%, or up to 60% to the taxman.
This ‘stealth tax’, where the marginal rate increases to 60% as contractors earn over £100,000 as a result of the personal allowance falling away, has caused many contractors to invest serious time and money in legal tax avoidance. Many are doing so for the first time.
Contractors have turned to a range of classic avoidance tactics, which include income splitting and channelling income into pensions. But this can only help rescue some of the additional taxation that has been placed on their shoulders. In other words, for higher paid contractors, allowable income splitting and pension payments have still not kept them below the £100,000 threshold, or even the £35,000 higher rate tax band for ultra-tax-averse contractors.
So better off limited company contractors have stopped declaring large dividends and are opting instead to build up cash piles in their contractor limited companies in the hope that tax rates will reduce. Cash sitting on deposit in business bank accounts is not doing anything productive for contractors or for the economy.
And it means less ‘real’ money going into the UK’s economy through personal spending, forcing more ‘fake cash’ to be pumped into the economy in the form of quantitative easing – in effect, that leads to currency depreciation and is another stealth tax.
Introducing the 50% top rate of tax was intended to ensure that those with the broadest shoulders in income terms bore the greatest tax burden. But let’s not forget that the top 1% of earners (which is just 300,000 taxpayers, including many contractors) already pay 27% of all income tax.
Unfortunately, the law of unintended consequences has dictated that the original idea behind the 50% tax rate is not working according to plan. Contractors and other high earners have got savvy and are not only avoiding paying the tax, but have also been forced into investing more time into general tax avoidance.
Far from generating more money for the Treasury, the 50% tax rate appears to have had the opposite effect.