Moves to compensate people hit by the axed 10p tax rate will push thousands more people onto a higher rate of income tax, experts have warned.
Chancellor Alistair Darling announced on Wednesday that in order to help low-income households hit by the abolished 10p tax rate, he would increase personal allowances by £600 for the tax year 2008/09. To avoid the move benefiting those paying a higher rate of tax, Darling also slashed the higher tax rate threshold by £600 which, when combined with the increase in personal allowances, brings the threshold to £34,800.
According to Mike Warburton, tax expert at Grant Thornton, around 100,000 more people will be forced onto a higher rate of tax because of the lower threshold.
Before the new measures were announced, people earning over £41,435 were taxed at the 40% higher rate. However now, even taking into account higher personal allowances and a lower threshold, those earning more than £40,835 now face a 40% rate of income tax.
Warburton says: "The object was to make sure higher rate taxpayers don't benefit from the compensation, with the result actually being more higher rate taxpayers."
And even more middle-earners could be dragged onto a higher rate of tax going forward.
Although Darling says the increase in personal allowances is for one year only, Nigel May, tax principal at Macintyre Hudson, believes the chancellor could use the lower threshold to his advantage at next year’s Budget.
“We can expect to see the higher rate threshold increase at next year’s Budget,” he explains. “The question is, will Darling revert the threshold to £36,000 before implementing an increase or will he take advantage of the lower base to raise some much needed extra finances?”
May warns that instead of the threshold increasing to the expected level of £36,000 next Budget, it could increase to just £35,200 - £700 below the threshold before the government announced these compensation measures.
If this does happen, then thousands of middle-earners could be pushed onto a 40% rate of income tax.
May adds: “While the chancellor stated that the measures are for one year only, it is not unimaginable that, come next year, he uses the opportunity of a lower threshold to raise some desperately needed extra money.
“People on salaries around the £40,000 mark will suffer as a result, despite many not considering themselves to be higher earners.”
Warburton agrees that Darling’s measures may not be around for just one year. “The chancellor says this is a one-off measure but is he really going to increase personal allowances one day and decrease them again the next?” he says. “Darling now faces either blowing the fiscal rule or keeping the threshold for the higher rate of tax at £34,800.”