Higher personal allowances and lower tax rates are not stopping millions more taxpayers being hauled into the higher rate tax band, according to a government report.
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Although Chancellor George Osborne boasts more people are paying less tax, the truth is more are paying tax at a higher rate to compensate.
A report from the independent Office for Budget Responsibility (OBR) reveals 10 million extra taxpayers will pay tax at the higher rate by 2033 – currently 40% – if the current earnings threshold continues to rise in line with inflation.
Currently, a taxpayer can earn £41,865 a year including the personal allowance before paying higher rate tax.
The government has reduced the threshold while increasing tax allowances in recent years, meaning more taxpayers are caught by fiscal drag.
Fiscal drag
Fiscal drag means the average tax rate increases if rises in allowances and thresholds are linked to the increasing cost of living rather than earnings.
The result is that if wage rises outpace price increases, more people pay tax at a higher rate.
Around 5 million people pay higher rate tax now – and the number is increasing each year.
The result is increasing allowances and reducing tax rates looks as if fewer people are paying tax, but the government compensates by taking more money from middle-earners.
The OBR report calculates the number of income tax payers will jump from 29.9 million this year to 31.1 million in 2033-34.
The figures reveal 4.6 million people pay tax at the higher rate of 40%, while 300,000 earning £150,000 a year or more pay at 45%.
Earnings outpace inflation
If the current tax policy persists until 2033, the OBR reckons 9.2 million will pay income tax at the higher rate, while 1.7 million will pay at the top rate.
The proportion of the workforce paying tax at 40% or more will switch from around 16% now to about a third by that time.
An additional 4.3 million would pay income tax by 2033 if allowances and thresholds continue to be increased in line with prices rather than earnings.
The policy would also see 200,000 less basic rate (20%) taxpayers as wage increase shifted workers up the tax bands.
“The reason underlying these tax changes is that earnings are expected to rise faster than prices in the long term as inflation sticks around 2%,” said the OBR report.
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