Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.
Of all the anomalies in Britain’s madly complicated tax system the effective 60% tax rate on earnings of between £100,000 and about £125,000 is one of the craziest – and a cause of deep frustration for the ambitious, who may wonder why they should bother going for promotion or a bonus.
When I was researching our article on the origins of the 60% tax band and ways to avoid it, I created a spreadsheet to make sure I had my numbers right. It also enabled me to play a ‘what if?’ game with the figures. This made me stumble on the fact, mentioned in that article, that the government could, courtesy of some innocent-sounding tweaks, increase the effective tax rate above £100,000 to 80% or even 100%!
Imagine the uproar if the chancellor got up on Budget day and said: ‘Mr Speaker, I propose that those who earn £100,000- £112,570 should in future be taxed at 100%.’ I suspect fewer would complain, or pay much attention, if Rachel Reeves said instead: ‘Mr Speaker, rather than the personal allowance being withdrawn at a rate of 50p for every £1 earned above £100,000, it will in future be withdrawn at a rate of £1.50 for every £1.’ But the effect, as I explained in that earlier article, would be exactly the same: an effective tax rate of 100%. Withdrawing the personal allowance pound for pound would result in an 80% effective tax rate.
Even more interesting is what happens if you go in the other direction and reduce the speed at which the personal allowance is withdrawn once your earnings exceed £100,000. If we reduce it from the current 50p for every pound of extra salary to 40p, the effective rate of tax on the additional income falls from 60% to 56%, my spreadsheet says; at 30p for every pound it is 52%. At 20p it’s 48%.
In all these cases though, the effective rate is still higher than the ‘official’ top rate of tax (in England, Wales and Northern Ireland at least) of 48%. This means that once your salary rises to the point at which the personal allowance is entirely withdrawn, we would still have the absurd situation of a rise in the effective rate followed by a fall – just as we have at present: the top rate goes from 40% to 60% at £100,000 and then falls back to 45% at £125,140, as shown on the graph below.
Then the question for my spreadsheet becomes: at what rate of withdrawal of the personal allowance does the effective rate of tax drop to 45%, which would mean that we no longer had that ridiculous step up followed by step down? The answer, it says, is to withdraw the allowance by 13p for every extra pound of income. That way, the rate of tax only ever goes up with an increasing salary, from 40% below £100,000 to 45% above it. This assumes that the ‘official’ 45% tax band begins as soon as the effective 45% band ends, in other words as soon as the personal allowance has been withdrawn entirely.
Where does this happen? According to my sums it will be at an income of £196,692. Now Labour may say this is too high a salary at which to have even a sliver of personal allowance left. But the party also claims to be ‘progressive’ – and the definition of a progressive tax regime is one in which the tax rate rises as you earn more. The current system, with its fall in the tax rate at £125,140, palpably fails that test. Labour also says it wants economic growth, and it may find that removing the 60% tax band, and with it those ups and downs in the tax rate, is one way to encourage employees to work harder or budding entrepreneurs to start businesses.
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. Tax treatment depends on individual circumstances and all tax rules may change in the future. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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