Planned 45% rate 'will cost money'

The Treasury’s plan to raise the income tax rates of high-earners has been put in doubt by the Institute for Fiscal Studies (IFS), which has suggested that the move will actually cost the Government money.

The think-tank has claimed that proposed legislative changes are ‘very unlikely’ to raise the predicted revenue and would more plausibly reduce the amount gathered unless ministers take steps to discourage people from reducing their taxable income.

The Treasury forecast in November’s Pre-Budget Report that it would raise £1.6 billion by introducing a new 45% income tax rate on incomes above £150,000 from April 2011.

A new briefing note from the IFS highlights the fact that the last set of changes to the highest income tax rates - in the late 1980s - led to earners reducing their taxable income by measures such as working less, contributing more to private pensions, converting earnings into capital gains or corporate income, and taking early retirement.

If high-earners respond in a similar fashion in 2011, the new 45% band will actually reduce the Government’s revenue slightly, argues the think-tank’s paper, which suggests that the reform will probably raise only around £550 million.

The Treasury also proposes to withdraw the income tax personal allowance in two stages from those with incomes over £100,000 from April 2010, creating two bands (£100,000 to £106,475, and £140,000 to £146,475) in which the effective marginal income tax rate is 60%.

The IFS’s briefing note - Can More Revenue be Raised by Increasing Income Tax Rates for the Very Rich? – argues that the Treasury’s estimate that this too will raise £1.6 billion is more reasonable, but the authors go on to insist that these spikes will complicate the income tax system significantly with little economic rationale.

The paper concludes that an alternative way of raising £3 billion would be to abandon both the 45% income tax rate and the phase-out of the personal allowance for those with incomes above £100,000, and replace both with an increase in the higher rate of income tax from 40% to 43%.

Senior IFS research economist James Browne commented: ‘Alistair Darling’s income tax increases for the rich will significantly complicate the tax system, and may well raise little revenue.

‘A simpler and smaller increase in tax rates across a broader range of high-income taxpayers would raise the money the Treasury is looking for more efficiently, especially if combined with measures to make income tax harder to avoid.’

Categories: News , IFS , Income Tax