How income tax has become such a nightmare for so many

WHENEVER you hear a politician promising that a painful measure will be purely temporary, run for the woods, tin hat in hand. The most painful of all policies, the income tax, was first introduced in Britain as an emergency measure to pay for the Napoleonic wars.

From the beginning, as Kwasi Kwarteng and Priti Patel, two Tory MPs who deserve to go far, point out in an excellent pamphlet from the Free Enterprise Group, it was a “progressive” tax, beginning at 2d in the pound for incomes over £60, and increasing to 2 shillings in the pound for earnings over £200, a 10 per cent rate. In 1909, Lloyd George introduced a supertax, originally at double the basic rate at 7.5 per cent, and intended to hit those on incomes above £5,000 a year, then a hundred times average earnings and equivalent to around £500,000 today.

Such restraint didn’t last. In 1914, the standard rate of income tax was 6 per cent. By 1918, it reached 30 per cent, with the “rich” facing ridiculously high rates, again because of a war. In 1938, only 4m taxpayers paid income tax. By the end of the Second World War – yes, there is a trend here – 12m families paid it. Today around 29.9m people pay the tax.

The introduction of income taxes around the world have tended to follow a very similar pattern over the past couple of centuries. First, we get generally low income tax rates, with most people exempt and with the highest rate only affecting a few people relatively lightly. Eventually, tax rates shoot up for everybody – including to crippling levels for top earners – and millions more are caught by income tax. The next stage is that the ultra-high tax rates for top earners are reduced to manageable levels – but ever more people are brought into the tax system, with the higher brackets also catching vastly more folk.

The biggest change in the UK has been the number of people paying what is now the 40p tax rate: up six-fold in thirty years, from 674,000 in 1979-80, 2.5m in 1999-2000 to 4.048m in 2011-12. This number will jump again to around 5m in 2014, according to the Institute for Fiscal Studies. When Margaret Thatcher came to power, just 2.6 per cent of taxpayers paid the top rate; by the time of the next election, 16.7 per cent will. The salary required to pay the top rate has remained roughly constant in real terms. But wages have gone up faster than inflation over the past few decades, dragging more and more people into the 40p bracket.

This process has been accelerated by the Chancellor’s decision to increase the personal allowance while ensuring those on higher incomes don’t benefit. Every time the tax-free amount has gone up, the threshold at which the 40p rate kicks in has come down. This has turned a good policy – cutting taxes for the poor – into a stupid one – massively increasing the marginal tax rate on hundreds of thousands of people who earn under twice the average income.

Anybody earning just £41,450 in 2013-14 will pay an incentive-destroying top tax rate originally intended for those on very high incomes. Yet in April 2011, median annual earnings in London were £33,847 on one measure, according to figures cited by the report. As Kwarteng and Patel point out, taxpayers in London and the Home Counties, who tend to earn more but face high living costs, are being hit especially badly: there is no equivalent to the London weighting for taxation. It is hard to know what is most depressing: the fact that Britain has become such a horrendously over-taxed nation, or the fact that neither the Tories nor Labour are going to do anything about it.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath

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