Chancellor George Osborne is expected to trumpet pre-general election tax cuts in his forthcoming Budget 2014 – but financial experts are warning the financial rabbit he is pulling out of his hat is really smoke and mirrors.
Repeatedly, Osborne has stood at the Despatch Box in Parliament and told the country that there is no spare money for tax cuts and that any budget benefits have to be paid for out of savings elsewhere.
That means if one taxpayer is benefitting from a tax cut, someone else is paying more.
So how does the government promise fewer people are paying tax?
The Chancellor’s tax tools
The answer is by manipulating two tax tools – interest rates and thresholds.
- Cutting the rate of tax for individuals or companies decreases the amount of tax the government collects, and as the Chancellor needs every penny he can raise to finance the borrowing deficit, cutting tax rates is a headline grabber but an unhelpfully decreases revenue.
- Tax thresholds hold the key to how the Chancellor maintains revenue but cuts income tax.
What George Osborne does is to put down the tax rate and the higher rate threshold at the same time, which increases the number of people paying less tax at the bottom end, but nets more middle income earners into the higher rate tax bracket at the top end.
Calculations by the Institute for Fiscal Studies argue that although 2 million lower income earners are paying tax, a million more middle income earners are paying higher rate tax.
So, taking 2 million people paying tax at 20% out of the system, but adding 1 million paying tax at 40% cancels out the tax saving.
Shuffling the numbers
The smart money for Budget 2014 is on Osborne increasing the lower rate threshold to £10,500, removing even more lower income earners from paying tax, but dropping the higher rate threshold at the same time.
The institute figures even a 1% rise in the higher rate threshold will mean anyone earning between £42,285 and £150,000 will pay extra tax at 40% because the threshold is moving at a slower rate than inflation.
If the rate had moved with inflation, the higher rate threshold would be £47,195.
“This has led to a million more people paying income tax at 40% since 2010,” said a spokesman for the institute.
The Chancellor’s juggling with tax does help lower income earners and is a hook for catching media and voter attention, but comes with a sting in the tail.