Another Stealth Tax - JOHN T NEWTH FCA, FTII, FIIT, ATT highlights a nasty shock for self-employed taxpayers on modest incomes.

THE ACTIVITIES OF the Low Income Tax Reform Group have, quite rightly, earned many plaudits, and recently earned one of Butterworths Tolley's tax awards. TaxAid should also be commended for its ongoing campaign to obtain bereavement allowance for widowers.

Despite reports of the vast incomes earned by professional footballers, city traders and others, there are still many people surviving on modest earned incomes. Others earn modest amounts from part-time self-employed activities.

Small taxpayers will have received three bonuses when they face their 2000-2001 tax bill. The personal allowance is increased by a modest amount from £4,335 to £4,385. And the basic rate of tax is reduced from 23 per cent to 22 per cent, with an accompanying nominal increase of £20 in the lower rate band of 10 per cent.

Against this, the same taxpayers receive two nasty shocks, one well advertised and the other less so, and disproportionately draconian in its effect. Firstly, the married couple's allowance of £1,970 at 10 per cent is withdrawn. Secondly, and far more penalising, Class 4 National Insurance contributions are radically increased. The percentage increase from 6 per cent to 7 per cent is perhaps minimal, but it is the reduction in the lower threshold from £7,530 to £4,385 (the equivalent of the personal allowance) that does the damage.

The effect of these changes can best be illustrated by an example. Take Bruce, a married taxi driver who is only able to work part-time for health reasons. His net assessable self-assessment income is £15,000 and his tax calculation for 1999-2000 is as follows:

Let us assume in this instance that Bruce's payments for 1999-2000 are paid on the due dates, and that tax and National Insurance contributions for 1998-1999 are £2,509.15. This means that tax of £1,254.58 was paid on 31 January 2000 and £1,254.57 on 31 July 2000.

Class 2 National Insurance contributions will have been £6.55 a week, making a total of £340.60. Total tax and National Insurance amount to £2,849.75 for 1999-2000. Although only 19 per cent of net earnings, this total does seem a large amount for someone on an income of £15,000. Multi-national companies often get away with paying a lesser percentage of tax on their vast profits.

Although Bruce's net earnings remain at £15,000 he faces a nasty shock in 2000-2001. His tax for this year is calculated as follows:

Nasty shock

As can be seen, the crunch comes on 31 January 2001 when the total tax due will be £1,834.78, an increase for Bruce of £580.20 over previous half-yearly payments. Admittedly the payment on 31 July 2002 will be £1,447.98, but the increase in the lump sum payment of tax is substantial for someone on such a modest income. In practice, the shock for many self-employed people will be worse as their profits are likely to be on a rising trend.

For completeness one has to acknowledge that the Class 2 National Insurance contributions are reduced to £2 a week for 2000-2001, so that the total tax and National Insurance contributions will be £2,895.95 plus £104 = £2,999.95. However, the percentage rate of tax and National Insurance contributions increases from 19 per cent to 20 per cent. One wonders how many voters are aware of this fact – especially those on modest incomes who have been given to believe that their tax rates have been reduced.

In order to simplify the examples, the question of children has been ignored. If Bruce had children up to 16 years of age he may be able to use the entitlement to working families' tax credit to reduce his payment on account for 2001-2002. However, this aspect is beyond the scope of this article.

For tax purposes those earning relatively small amounts from self-employed businesses are in for a nasty shock on 31 January 2002 – whatever the colour and ideology of the government then in power.

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