Income Tax

What is Income Tax?

Income Tax is the principal form of direct personal taxation in the UK. It takes the form of a proportion of a person's earnings, which is collected by HM Revenue & Customs and passed to the Treasury. Income Tax was previously collected by the Inland Revenue, but in April 2005, Inland Revenue merged with HM Customs and Excise Departments to form the present HM Revenue & Customs (HMRC).

The main forms of income that are liable to Income Tax are earnings from employment and self-employment, retirement pensions, profits from business, income from property, interest on savings and dividends from investments. It is also payable on Jobseeker's Allowance and tips and bonuses.

Deductions for Income Tax are usually made "at source": that is, they are deducted by the paying authority (the employer) and passed to HMRC without ever reaching the individual. Self-employed people, however, must assess their own tax liabilities and make any necessary payments to the taxation authorities themselves.

The types of income exempt from Income Tax are most means-tested benefits, employer or employee pension contributions, student grants, loans or scholarships, and earnings from certain types of saving products, such as National Savings Certificates and Individual Savings Accounts.

UK residents are allowed to earn or receive a certain amount of taxable income each year tax-free. This is known as a 'Personal Allowance'. A Blind Person's Allowance may also be added to the Personal Allowance for those registered blind.

For people under 65, the Income Tax personal allowance (the amount you can earn before you pay tax) increased to £9,440 in April 2013.

For people over 65, related allowances froze in April 2013.

From 2014-15, taxpayers will receive a new Personal Tax Statement, telling them how much Income Tax and National Insurance they have paid and what their money is being spent on.
 

Background

Income Tax was the first tax in British history to be levied directly on people's earnings. It was introduced in 1799 by the then Prime Minister William Pitt the Younger, as a temporary measure to cover the cost of the Napoleonic Wars.

Today, it remains a temporary tax, which expires on April 5 each year, and has to be renewed as a provision in the annual Finance Bill. The Provisional Collection of Taxes Act 1913 permits the Government to continue to collect Income Tax for up to four months after the expiry of the measure, until the Finance Bill becomes law.

Deduction at source was introduced in 1803 by Henry Addington. At this time, the amount charged was reduced from the original rate of 10 per cent on incomes in excess of £60 per annum, but the earnings threshold was widened to double the size of the liable population.

Income Tax was formally repealed in 1816, a year after the Battle of Waterloo, but it was reintroduced in 1842 by Sir Robert Peel to deal with a massive public deficit. At this time, it was levied only on the very rich, and it remained so for many years. In 1874, it contributed only £6 million of Government revenues of £77 million.

Income Tax rose dramatically in the early 20th Century. A new range of taxes and rates was introduced in 1907 by Herbert Asquith. In 1909, an alternative to Income Tax for high levels of earnings, called the "Surtax" or "Super Tax" was introduced. Super Tax survived until 1973, when it was replaced with the Higher Rate of Income Tax.

By 1918, the standard rate rose to 30 per cent, which brought in £257 million per annum, on top of £36 million from Super Tax. Moreover, by 1930, 10 million Britons were liable for Income Tax.

Income Tax was extended to a larger proportion of the population and its rates increased again in 1945, to pay for the Second World War effort. The current Pay As You Earn (PAYE) system for deducting tax at source was introduced in 1944, replacing the previous system of annual or six-monthly collection. The "tax code", telling employers the proportion of income to be deducted, and the P45 form was introduced alongside PAYE.

Throughout the postwar period, the trend in rates of Income Tax was upwards, as the state increased its range of responsibilities. This was reversed under Margaret Thatcher. During her period as Prime Minister, the Basic Rate of Income Tax was reduced from 33 per cent to 25 per cent, and the Higher Rate from 83 per cent to 40 per cent, as part of her drive to reduce the "size" of government and free up private incomes.

Following the 1997 election the new Labour government promised not to increase the Basic Rate of Income Tax, and it remained at 22 per cent until 2007, when the Chancellor, Gordon Brown, reduced it to 20 per cent with effect from April 2008.

The present Coalition government announced that it would increase the Personal Allowance by £1000 in 2011-12 bringing it up to £7,475. This they claimed would take 880,000 people out of income tax altogether. The Government also pledged to gradually increase the Personal Allowance to £10,000 over the longer term.

Controversies

Throughout its 19th Century history, no one expected Income Tax to become a permanent feature of British life. However, as it became accepted (particularly after the World Wars) that the state should do more to provide services for citizens, the long-lived tax evolved into the principal means of public funding.

Today, few criticise the concept of Income Tax itself, and controversy focuses on the rate and those elements of earnings that are liable. Income Tax is one of the most high-profile of all taxes (not least because of its simplicity and transparency) and as such fluctuations in the regime are frequently headline news.

In the 1980s, the Thatcher Governments argued that heavy rates of marginal taxation on high earners were a disincentive to entrepreneurship and hard work. This remained the political orthodoxy for Labour and the Conservatives, although the Liberal Democrats proposed a new higher rate for incomes in excess of £150,000 per annum.

In 1997 and 2001, Labour undertook not to increase the Basic Rate of Income Tax. The motives for this were both political (the unpopularity attendant on Income Tax rises, illustrated by Labour's performance in the 1992 general election, and the desire to avoid the cycle of taxes being cut before elections only to rise afterwards), and economy ( in order to increase financial certainty and stability).

While it did not increase Income Tax, critics of the Government pointed to increases in other taxes and the introduction of new taxes, claiming that the tax burden continued to rise in spite of the Government's eschewal of this primary lever. The Conservatives dubbed these measures "stealth taxes", claiming that the Government was continuing to take more money from the public, but through opaque and diffuse measures rather than the transparent (and therefore politically difficult) means of Income Tax.

The types of income liable to Income Tax are also a source of controversy. The taxation of pensions and the savings of those on otherwise low incomes has attracted criticism. It has been argued that the majority of pensioners do not have large pensions, and that the system punishes those who have made provision for their retirements by accumulating modest levels of savings.

The abolition of the Married Couple's Allowance (an increased exempt personal allowance) in April 2000 was widely criticised by social conservatives for discouraging marriage. The Government argued that the system had been replaced by Child Tax Credit in April 2001, but the change of emphasis from marriage to children did not satisfy critics, who continued to call for its reinstatement.

The Married Couple's Allowance was abolished for all except those in marriages and civil partnerships where one person was born before April 1935, in which case an allowance may still be claimed.

In the run-up to the last General Election the Conservative Party outlined plans to give tax breaks to married couples and those living in civil partnerships. The plans were roundly criticised by Labour who claimed that child benefits would be cut to fund the scheme. There were also concerns that single parent families would lose out. The Liberal Democrats were also critical of the proposals.

Since the election the Prime Minister, David Cameron, has indicated he still wishes to support marriage, or 'commitment' as in civil partnerships, via some kind of transferable tax allowance. This appears to be one area on which the two Coalition partners still disagree; however, provision is made in the Coalition agreement for the Liberal Democrats to abstain on any such budget resolution.

The previous Labour government disputed claims that the tax burden had risen, but most commentators accepted that the tax system had become considerably more complex and therefore less comprehensible to the layman in recent years.

The Coalition stated in its 'Programme for government' that it believed the tax system needed to be reformed in order to make it "more competitive, simpler, greener and fairer"; and the new Government said action would be taken to ensure that "the tax framework better reflects the values of this Government."

Coalition chancellor George Osborne later decided to cut the top rate of income tax from 50p to 45p, in a move which was widely seen to have damaged his claim that "we are all in this together" when it came to deficit reduction. The Treasury claimed the tax cut would bring in more revenue, but some tax experts said the one year lifespan of the top rate meant it was impossible to really evaluate how well it functioned.

Statistics

Income Tax Allowances:

Personal allowance 2012-13

Under 65: £8,105   Age 65-74: £10,500   Age 75+: £10,660

Personal allowance 2013-14

Under 65: £9,440   Age 65-74: £10,500   Age 75+: £10,660

Married Couple's Allowance:

Allowance: Age 75+  2011-12: £7,295  2012-13: £7,705  2013-14 £7,915
Minimum amount: 2011-12: £2,800  2012-13: £2,960  2013-14 £3,040

Income Tax bands:

Start savings rate: 10%: 2011-12: £0 - £2,560  2012-13: £0 - £2,710  2013-14: £0 - £2,790
Basic rate: 20%: 2011-12: £0 - £35,000  2012-13: £0 - £34,370  2013-14:  £0 - £32,010
Higher rate: 40%: 2011-12: £35,001 - £150,000  2012-13: £34,371 - £150,000  2013-14: £32,011- £150,000
Additional rate: 50%: 2011-12: Over £150,000  2012-13: £Over £150,000  2013-14 N/A

In April 2013, the top rate of Income Tax was reduced from 50 per cent to 45 per cent.

Income Tax reliefs that are not already capped will be capped at £50,000 or 25 per cent of income, whichever is higher.

The main rate of Corporation Tax will reduce by an additional 1 per cent to 24 per cent from April 2012.

Source: Gov.uk, 2012, 2013; HMRC.gov.uk, 2013
 

Quotes

"My goal is a tax system where the lowest paid are lifted out of tax altogether, while the tax revenues we get from the richest increases."

Chancellor George Osborne, Budget statement - March 2012.