Tax system flaws leave professionals paying 60 per cent

'Nonsensical' tax cliff-edge leaves families paying hidden marginal tax rates in system that has 'no plausible rationale', Institute for Fiscal Studies says

Many middle-class professionals are paying an income tax rate of 60 per cent as a result of a little-understood policy introduced by the last Labour government which affects more than 500,000 people, a leading economist has warned.

The Institute for Fiscal Studies (IFS) said that it is "hard to make much sense" of a loophole in income tax rules which means that those earning between £100,000 and £120,000 now pay 60p of every pound they earn in tax.

The hidden tax rate is a third higher than the 45p top rate of tax which is widely believed to be the maximum raid on income.

Paul Johnson, the director of the IFS, said that there was "no plausible rationale" for the income tax system and accused Governments led by both main parties of introducing "poor tax policies".

"There is a basic rate of income tax of 20 per cent, a higher rate of 40 per cent and a top rate now of 45 per cent," he said. "What is less well known is that the last government introduced a rate of 60 per cent on a band of income starting at £100,000. This government has maintained it and effectively increased its range considerably. There is now a 60 per cent rate of income tax on income between £100,000 and £121,000 (where it drops back to 40 per cent). It’s hard to make much sense of that."

He added that the failure of successive Governments to increase the income levels at which the higher rates of tax become payable had dramatically widened their reach – "fundamentally altering the nature" of the income tax system.

"The point at which the 45p rate becomes payable, and indeed the point at which the 60p rate becomes payable, is fixed in cash terms and has already fallen by more than 12 per cent relative to the Consumer Prices Index [inflation] since its introduction," he said. "More people will gradually be pulled into these higher rates. There is apparently no plan to stop this."

The IFS analysis identified 11 major other areas of the tax system as being unfair – eight introduced by Labour which have not been reversed by the Coalition, and three new sets of policies introduced by George Osborne.

In an attack on the UK tax system Mr Johnson also said:

-- Stamp duty taxes are "one of the worst designed and most damaging of all taxes" which will soon raise £15 billion annually. In the most extreme cases, a £1 increase in sale price can trigger an additional £40,000 tax bill. "The tax helps to gum up the entire property market".

-- Changes to the pension regime introduced by Labour introduced an "absurd complication". The system has been blighted by "short term meddling and complication" and policies pledged by Ed Miliband threaten to "further complicate" the situation.

-- The imminent introduction of a married couples’ tax allowance, which will be gradually withdrawn for higher-rate taxpayers, is also beset by problems. "Since the full value of the allowance is withdrawn as soon as one partner becomes a higher rate tax payer, it is possible to become more than £200 a year worse off as a result of a £1 pay rise."

-- Council tax bills are now assessed on property values which will soon be 25 years out of date. "This situation is becoming increasingly absurd".

-- Governments "of all stripes" have "continually" cut income tax while increasing National Insurance. This is described as being "politically easier".

The intervention by the IFS will add to the growing pressure on George Osborne to radically reform the tax system if the Conservatives are re-elected to help the middle classes.

Both Mr Osborne and David Cameron have repeatedly stressed that their priority is to help the lower paid. However, a growing number of Conservative MPs believe that help must now also be forthcoming to help higher-rate taxpayers.

Mr Johnson said that politicians are "culpable" for "poor tax policies" that mean many middle-class households lose more than half of the value of any pay rise to the Exchequer.

Those affected by "cliff-edge" tax rates include married couples, middle-class families and successful professionals.

The 60p rate occurs because those earning between £100,000 and £121,000 lose their tax-free personal allowance which means they pay higher rates of tax on this portion of their income.

In a speech to financial experts in London, Mr Johnson criticised both current and past minsters for repeatedly making complicated and poorly-explained changes to the tax system, creating anomalies and inconsistencies that affect millions of people.

He said: "Complexity, uncertainty and inefficiency in a tax system which takes £4 in every £10 generated in the economy costs a huge amount in lower welfare, less economic output and straightforward inequity.

"Even if we can’t have perfection, something close to coherence and consistency would be nice."

The IFS expects there to be 5.3 million higher and additional-rate taxpayers in 2015-16, up from 3.3 million in 2010-11.

That shift lacks democratic legitimacy, Mr Johnson suggested.

"The problem is not necessarily so much the fact of the change – there is a case for, and a case against, such a system – but the fact that this fundamental change to our tax system, which appears to have the support of the three main political parties, has never been announced or properly debated.

source : telegraph.co.uk