Should the UK Government Restore the 50 Percent Additional Rate of Income Tax - Essay Example

Should the UK government restore the 50% additional rate of income tax? Contents Introduction 3 Discussion 3 Recent history of the additional rate ofincome tax 3 A discussion of the arguments 7 Conclusion 10 Introduction Budget by any government comprises of two parts income and expenditure. The income mentioned in the budget comprises of the income generated through taxation. Taxes may be collected either by the central or the local government. There are divisions between what taxes will be collected by the central government and what will be collected by the local government. The taxes collected are generally of two types, direct tax and Indirect tax. Direct tax is a form of taxation where the burden of taxation is directly borne by the individual on whom it is charged. The burden of having to pay the direct tax cannot be shifted like that of indirect tax. Income tax is progressive in nature. This means that the amount of tax that one has to pay increases with the level of income that the person earns. The net taxable income of a person is divided into slabs for the charging of income tax. For the lower slabs there is no provision of income tax where as the percentage to be paid as taxes increases progressively as one move to the higher slabs. There are of course certain allowances that are enjoyed by an individual to allow him certain concessions in the income tax levels. Discussion Recent history of the additional rate of income tax Europe has a long history of charging taxes. Taxes were first levied on subjects or people back in the 17th century in the form of uniform land taxes. This source of revenue remained the main source of income for the government throughout the 17th, 18th and early 19th century. Income taxes were first introduced by William Pitt the younger in 1798 in order to pay for the weapons to be required in the Napoleonic wars (Tiley and Loutzenhiser, 2012). Pitt made income tax rates Progressive from its implementation. He hoped that through this new system of taxes he would be able to raise around £10 million but he was able to raise only £6 million. Income tax rates are generally progressive in nature. This means that as percentage of income rise the amount of taxable income and tax levied also rises in equal proportion. This fact can be shown from the below mentioned graph. Figure 1: Income and tax levels (BBC, 2011) Income tax is made progressive or higher income groups of people are charged more than the lower income group. This is made to counteract income inequality in society. The government always argues that in order to give benefits it has to raise income taxes. In fact when calculating benefits given to the masses; the benefits are taken as standalone figures and not comparing with tae taxes that people have to bear. But the real calculation should involve comparing benefits with taxes paid. For example, in 2010-11 the poorest of the population received benefits amounting to £104 per week however if we deduct the taxes paid the amount comes out to only £36/week or £5 per day. The effect is clear from the below chart. Figure 2: comparison of benefits and taxes (Duffy, S. 2013) From the graph is clearly noted that the poorest 40% of the population are the ones that are really benefited. That too the total benefit amount comes out to be only about £28 million which is just 3% of the GDP. On the contrary, the top 60% of the population gives around £213 billion in taxes. It is clearly noted as claimed to be the actual reason for income tax, the taxes in practice do not help in alleviating poverty or redistributing income (Petrakis, Kostis, and Valsamis, 2014). Historically however the level of basic rates of income taxes has been reduced from 33% in 1978 to 20% level in 2014. The rates of taxes for higher income group have also witnessed a sharp fall. On coming to power in 1979 Margaret Thatcher the then British PM and her government reduced the tax rate on high income group from 83% to 60%. It was further reduced to 40% in 1988. It had stayed at the 40% level ever since till the time the labour party introduced the 50% level before their last general elections (Andersson, Eberhartinger and Oxelheim, 2007). The introductions of 50% tax revive for the ultra rich was created to Help Britain’s finances come out of the global financial crisis that occurred in 2010 (Goodley, 2014). As compared to other countries the contribution of income tax in GDP of UK is less. Does 50% tax bracket mean that if one’s income is 180,000 pounds then one has to pay 90,000 pounds as taxes? No it is not like that. In fact taxes are paid in slabs. The slabs are divided such that the first £9,440 is free; it is charged at a basic tax rate of 20% for income level between £9,441 and £41,450 (OECD, 2007). Between £41,451 and £150,000 it is charged at 40% and above £150,000 at 50% (Meade, 2013). So if one’s income is £180,000 then the amount of tax one has to pay is = 0% (9441) + 20% (41450-9441) +40% (150000-41451) + 50% (180000-150001). The amount comes out to be £64,820.9. As compared to this earlier the individual had to pay £61,821. The amount to be paid for the higher income group as income tax is £14999.5. Earlier the higher income group had to pay £ 11999.6 as taxes. The progressive nature of the taxes ensures that the top 1% of the population earn 13% of the total income but contributes about 28% of the total taxes (Chapman, 2014). As compared to this figure the bottom 50% of the tax payers paid only 11% of income tax. To see how tax burden is shared let us look at the following figure. Figure 3: How is income tax burden shared (Pollock, 2012a) But the question remains as to whether the extra tax rates or charging the high income economy group really helps. Many economists are of the view that raising tax rate has more of a psychological impact than any real financial impact. The psychological impact lies in the fact that raising the income tax level will force the people to shift their income to other domains or move their money out of UK (Bernardi and Profeta, 2004). A discussion of the arguments Protesters, first in USA and then in financial centres across the world protested rising levels of inequality between the top population group and the rest of the population. In case of UK too it is seen that the share of the national income by the richest is at all time high. The percentage of national income in the UK held by the top 1% of the population after falling for about half a century has begun rising again and is back on its course to the same levels as of 1918. The following figure shows this case in point. Figure 4: Share of income received by the top 1% in U.K. (Robinson, 2012) The labour and conservatives are always at logger heads over the decision whether to introduce the 50% tax regime or not. Whereas the Labour party argues that since the income levels of top income group has almost doubled since 1996 so to bring down income disparity the tax rate is bound to increase to the 50% level. However Conservatives argue that introduction of the 50% tax regime will do more harm to the economy than any good. The labours suggest that 50% tax rate cannot be justified on the grounds that it does lasting damage to the economy and does not raise anything (Seely, 2014). The UK economy has been long suffering from budget deficit and Labour party suggests that introducing the 50% tax regime for the top economic group would help reduce this budget deficit and help the UK economy revive from the financial crisis (Karasavvoglou and Polychronidou, 2013). Figure 5: UK budget deficit (BBC, 2008) So, the question that arises is to find out what is the probable solution to rectify this apparent disparity in income levels. A study shows that rising in tax rate does not increase the tax revenue levels. It is because if income tax rates are raised, the people find alternative ways to avoid a greater tax rates. For example if income tax rates are raised people try to maximize their capital gains and vice versa. When the 50% tax rate was actually introduced the labour party claimed that it will be able to raise £2.5 billion. But it was found that the 50% tax rate for the income above £150,000 raised only £1 billion pound extra (Pollock, 2012b). The fact due to which the additional tax rate regime failed to generate extra revenues for the exchequer was because wealthy people took fare more steps than anticipated before to avoid paying greater amount in taxes. The key issue in implantation and collecting high taxes from the top wealthy class is that now days it is very easier for the high income group to move away from one country to another in order to save taxes. Mobility of labour across international boundaries has become pretty easy these days because both cost and legal implications in case of international migrations has decreased considerably. In fact raising the income tax rate only affects the people’s psychological mindset and there is an adverse effect on the amount of inward and outward migrations to and from Europe (HMRC, 2012). The additional effect of the 50% tax rate for the top income group was that the level of income declared dropped from £116bn in the year 2009-10 to £87bnb in the year 2010-11. Although, it is true that all of this decrease cannot be attributed solely to the introduction of 50% tax rate some of it can. The study by HM Revenue and Customs also suggests that had the 50% tax regime not been introduced the declared net income by people would be around £107bn as against the current declared level of £87bn. This is due to the fact that all those who could ensure pre emptive measures ensured that they shift some part of their income so that they had to pay fewer taxes (Karasavvoglou and Polychronidou, 2012). Figures brought forward by the HM Revenue and customs also suggests that since the time the 50% tax rate was abolished to reintroduce the 45% tax rate the total tax revenue collected has increased. The total tax revenue collected from people earning over £150,000 has shot up from £40bn last year to £49bn the current year. The introduction of 50% tax regime for the top income people has actually been costly for the British exchequer (Mirrlees, 2011). The top earners actually used loop holes in the tax structure to avoid paying extra taxes. The people in the income group, earning more that £2mn declared only £12.2bn in income figures in 2012-13. However the same group paid taxes amounting to £26bn the following year with the introduction of lower tax rate regime. In fact the conservative party argues that the tax revenue collected will increase further if the tax rate is further lowered. Another problem with high tax rate regime is that due to regime of high tax rate economic growth suffers. Evidence from around the world actually suggests that modest tax regimes actually raise more tax revenues than periods of high tax rate regimes (Young and Saltiel, 2011). Conclusion From the above discussion it is clear that although the labour party’s intentions seemed to be good at introducing a regime of high tax rate. However practical evidence shows that the 50 % tax regime did more harm to the economy than doing any good. In fact it has been found that increasing the tax rate actually leads to reduction in collection of tax revenues. Another fact was noticed the amount of revenue collected as a result of the increased tax rate was nowhere near to the projected figure. In fact it was found that in the period when additional tax rate was introduced the actual tax revenue collected was less in comparison to the following year when the rate was reduced to 45 %. It was due to the fact that when the percentage of income tax for the people whose income was above £150,000 raised to 50% level the people found additional loopholes in income tax to evade paying higher taxes. So, looking upon the above facts it is certain that the UK government should not restore 50% tax levels and should try some other measures instead to reduce the budget deficit or help it itself out of the financial crisis. References Andersson, K. Eberhartinger, E. and Oxelheim, L., 2007. National tax policy in Europe: To be or not to be? Vienna: Springer Science and Business Media. BBC, 2008. Darling unveils borrowing gamble. [online] Available at: http://news.bbc.co.uk/2/hi/7745340.stm [Accessed on 17 November 2014]. BBC, 2011. Higher tax rate to hit 750,000 more people, says IFS. [online]. Available at: http://www.bbc.co.uk/news/business-12321524 [Accessed on 17 November 2014]. Bernardi, L. and Profeta, P., 2004. Tax systems and tax reforms in europe. London: Routledge. 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