Analysis: Chancellor’s changes to tax offer cold comfort for middle earners

Less cause for sledging and mulled wine and more reason to wrap up warm and weather the freeze was George Osborne’s clear message.

No great headline-grabbing changes were announced, apart from the much trailed moves to curb the perceived culture of tax avoidance among large corporates, but that doesn’t mean the Chancellor didn’t lob a few well-aimed and potentially painful snowballs at middle-income earners in particular. Thousands of Scottish taxpayers are set to pay more income tax as a direct result of a measure that will drag them into the higher-rate tax band.

As many economic studies have shown, raising tax rates tends to have a negative impact on the overall tax take. With a nod to this body of opinion, income tax rates will not be increased further. Rather, as expected, the Chancellor confirmed his intention to reduce the top 50p rate to 45p from April 2013 (as was previously announced in the 2012 Budget).

To help the “squeezed middle” and provide relief to lower-income households feeling the effects of reduced welfare spending, he announced a further increase in the personal allowance, resulting in a total increase next year of £1,335. With people able to earn £9,440 before paying any income tax at all, the government is well on the way to lifting those on incomes of less than £10,000 out of income tax altogether.

But raising the personal allowance is expensive and funding this increase has been achieved by limiting the increase of the higher-rate thresholds to below inflation levels and further restrictions on pension reliefs.

As a result, more than 300,000 British taxpayers will be pulled into the higher-rate tax band, raising estimated additional tax of £1 billion by 2015-16. Here in Scotland, as many as 32,000 taxpayers could also be sucked into the higher-rate tax bands as a result of these changes.

Higher tax bills will hit families struggling to pay off mortgages and grappling with rocketing fuel bills and punitive petrol prices. While the scrapping of the 3p fuel rise will be welcomed by hard-pressed motorists, it is worth noting that the 3p hike planned for September 2013 will still go ahead – so they are not out of the woods by any means.

Earlier this year, research for the Institute for Fiscal Studies showed the higher-rate tax trap was hammering those earning “relatively modest” salaries. It also highlighted the huge rise in the percentage of all taxpayers caught in the 40 per cent tax net from 3 per cent in 1978 to an estimated 15 per cent next year.

So what impact will the changes to the thresholds have for the average Scottish taxpayer? There is good news for a household of two earners with two children earning £45,000 and £30,000 respectively. They will take home additional net income after tax of £466 in 2013-14, an increase of 0.81 per cent from this year. A lower-income couple earning £20,000 each and with no children will see an increase of 1.76 per cent (£569). These figures demonstrate that lower-income families should see a larger proportional increase in their after-tax income. However, they do not take account of the imminent changes to children’s tax credits, which are likely to leave some families noticeably worse off.

We saw continued pressure on higher earners from yet another reduction in pension tax relief, with the annual allowance to be reduced to £40,000 from 2014-15 and the lifetime allowance to fall to £1.25 million. The Chancellor stated that this will only affect the top 1 per cent of pension savers in the UK. However, these measures could have a negative impact by reducing confidence in the stability of the system for everyone, and penalising those who deliberately planned to increase pension savings later in life, rather than save a little each year. It is also key not to lose sight of the link between personal tax rates and attracting and retaining individual entrepreneurs in the UK so as to boost employment and business prospects in the longer term.

The Chancellor has argued that, despite the economic difficulties, there is considerable scope to increase the UK’s standing as a centre of excellence that fosters and attracts enterprise. However, getting there means sticking to the “open for business” agenda and doing more besides.

A further 1 per cent reduction to the main rate of corporation tax goes some way to achieving this, but many entrepreneurs will still think twice about starting up in the UK with the top rate of income tax at 45 per cent from April 2013 and only small, below-inflation rises in the capital gains tax annual exemption and the inheritance tax nil-rate band.

So, while the Autumn Statement did not perhaps light a roaring fire to immediately melt the economic chill, it avoided any big economic shocks and leaves the full impact of a snowball fight for another day.

• Susannah Simpson is tax director at PwC in Scotland