Is our Income Tax (and reliefs) system fit for purpose ?

Sorry, this is totally OT and a long post. Advanced warning to skip!

I have just completed the year end accounts for my company. I'm lucky, I earn more than the average bod, I'm able to employ family members and where I can I take advantage of tax breaks for ISA's and Pensions.
As expected, I'm a true blue voter. However, what I have discovered is an archaic and unfair system of taxation. It has to change. Here is how it is now (summarised but accurate) followed by my simple solution.

Lets call NI and Income tax the same. Forgetting the pennies, you can earn the first £8100 tax free. Figures below assume you are not an OAP in which case you can subtract 12% tax from the first 2 lines and 2% from subsequent ones.

You will then pay 12% tax on the next £2500
You will then pay 32% tax on the next £32,000
You will then pay 42% tax on the next £7400 (on the next £57400 if you don't have kids)
You will then pay 59.7% tax on the next £10,000 (assuming you have 2 kids)
You then go back to paying 42% on the next £40,000
You will then pay 62% tax on the next £21,200
You will then go back to paying 42% tax on the next £28,800
Finally, from £150k you will pay 47% tax on everything else.

For those are don't know why these figures are as they are, it's because, unless you are old, we all start paying NI at about £8100 at 12%, at £10600, 20% income tax kicks in. At £43600 income tax increases to 40% but NI drops to 2%. At £50k, if you have kids you start to repay the child benefit, with it all repaid by the time you have earned £60k. At £100, you start to lose the £10600 personal allowance at a rate of 20% until it's all covered. And then at £150k, the income tax rate increases to 45%.

My view is that basically these rates are about right, just unnecessarily complex. I think NI and TAX should be aligned so the government can't harp on that basic rate tax payers pay 20% tax (they pay 32%) and we should remove the lowest earners from paying tax at all, and that means NI.

Next onto reliefs. There are 2 big ones. ISA's and Pensions. Most of us try and save something into a pension, maybe through a work scheme and most of us (at least those earning up to £43k) will get tax relief on their pension contributions at their standard income rate of 20% (not the 32% - it don't work that way!)

So far so good, but how can it be just that someone earning 5 times the average wage will get 45% releif when someone on an average wage will only get 20% ? This means in simply terms that for Mr or Mrs average to put £1000 in their pension it will cost then £8000 in cold hard cash, where Mr or Mrs wealthy will only have to pay £5500.

That's not all. If you earn enough you can shelter £40,000 a year doing this. Many will be struggling to pay £40 a month into a pension, but £40k a year! And it gets worse. If Mr and Mrs Wealthy have not used their pension allowance for previous years they can back date up to 3 years, so could in fact this year pop £170,000 (3 years ago it was £50k in case you are wondering why I did not write £160k). That £170,000 would only cost them £93500 as the governament would GIVE them the remaining £76,500 as tax relief. A £76500 gift to the highest earning. That one gift is more than the average Joe currently has in their pension fund at retirement! Fair?

With ISA's (forgetting help to buy etc) one can save £15600 (this increases to £20k in April) a year and all the income and growth from this is totally free of tax. ISA's were designed to get people saving, but they are now being used by the very wealthy as another vehicle to shelter excesses from the tax man. It may surprise you but there are many ISA millionaires our there. If you have popped away with maximum allowed since their formation (we include their forerunners known as PEPS and TESSAS here) then you will easily have made it. And that's with historic contribution limits being much much lower. In fact, only 5 years ago the limit you could contribute was £5300.

£20,000 a year is NOT rainy day saving. It's now simply a vehicle exploited by the rich that the average Joe will be little and often no use of. Someone with a £1m ISA pot could be creaming off a further £50k a year without a penny in income tax whilst a Tesco worker is paying 32% tax without a hope of having anything spare on pop into an ISA.

For those who don't know, those with masses of savings that have exhausted their ISA can also pop £50k into premium bonds and have another £100k in a savings account and pay no tax on the interest (assumes 1% interest rate as all can earn £1k a year from savings interest tax free).

There, that's how it is now. Here's my solution.

Allign TAX and NI and set it at a rate of 30%: This will free all those earning between £8k and £11k from paying any tax. There will also be a 2% deduction of tax for all others.

Increase the higher rate tax limit to 45%: This is only a 3% increase from the current rate. And as these earners will have benefited from the 2% cut on the basis rate they will have to be earning over £70k before they are paying more tax than they are now

Abolish Child Benefit. Have is paid as part of child tax credits to those who qualify.

Let those earning over £100k keep the personal allowance. If someone is on £120k under my propsal the extra 3% on earnings over £70k more than covers this.

I've no idea how the above will add up in terms of affordability for the government, but as the biggest earners pay the most income tax and those earning over £70k a year will be paying more, then this may be a net gain for the government. Add to this the extra money low earners will take home, so may be less dependant on benefits.

Onto pensions. So easy. Make it a level playing field. All get tax refleif at the basic tax rate (which will be 30%).
Whether you earn £10k or £1m it will cost us all £700 to pop £1000 into your pension. I'd also kill the facility to use previous years allowances. It will be use it or lose it. £40k a year is ample to pop in your pension and is a pipe dream for 95%. To be able to shelter 4 times this figures is grotesque.

Finally ISA's: Limit the amount that can be hold in an ISA to £50,000. Again, this is an ample sum which will not be achieved by most, even in their wildest dreams. We don't need to be offering tax breaks to those wealthy enough to ammas more than £1m in rainy day savings.

Those with more than £50k in their ISA will have to move it to accounts that pay tax or spend it. The later being a boom for the economy.
I would also slash the amount that can be saved into an ISA each year to £6,000. This is £500 a month and the government really don't need to be passing cash to those who are fortunate enough to be in a position to save more.

For pensioners. I propose they are given an additional personal allowance of £2500 to compensate them for the higher tax they will pay with the merging of NI and TAX. A pensioner would have to have income of over £36500 before this new system cost them money

shorter version: flat(ish) tax, merge NI into income tax, keep the 40%, pension relief only at 25%, do away with all the credits and reliefs, IHT and other side taxes. apply the same principles to business, basic coroporation tax with a couple of bands, couple of core reliefs to promote industry/political caues, limited to say 5-6 (introduce one, get rid of another). this is the way to clean up tax and dispence with agressive avoidance, but wont happen because the accountancy industry and treasury would sufer from lower head count.

kingcole said:

Sorry, this is totally OT and a long post. Advanced warning to skip!

I have just completed the year end accounts for my company. I'm lucky, I earn more than the average bod, I'm able to employ family members and where I can I take advantage of tax breaks for ISA's and Pensions.
As expected, I'm a true blue voter. However, what I have discovered is an archaic and unfair system of taxation. It has to change. Here is how it is now (summarised but accurate) followed by my simple solution.

Click to expand...

Yet after all that you vote for a government that looks after the wealthy!

Kingcole; all very good stuff I am sure, but I'll have to read it tomorrow as it is a bit heavy for Sunday lunchtime.

The more you earn the MORE you pay, EVERY single persons tax is deducted at source through PAYE and anyone earning over £100k a year should pay at least 60% tax going up by 10% for every £100k earnt till anyone earning more than £500k a year pays 90% tax.
No tax fiddles and EVERYONES salary disclosed publicly every year and the amount of tax paid shown so we know just who is NOT saying their fair share.

#Kingcole Can I pick your brain a minute. Self employed earning £40K plus I employ my Wife who is on £20K thus keeping me below that high earner mark. I do my own books but get an accountant to check them off with an official looking document. Can you explain the pension bit for me and whether I should be paying into a scheme and claiming back tax. I'm 60 but will be working (an income) at least another 10 years.

You seem to have covered every tax saving scheme being utilised by every ''Owner Managed Company Director'' currently in existence except the ''Salary Sacrifice'' to qualify for ''Child CarePayments'' (Not Child Benefit) - One parent claiming for one child and second parent doing it for the second childwhich exempts those payments from NIC Employee and Employers if they have their own company.

Therein lies the problem - Only the people who can afford Accountants know about such reliefs so the poorest in society always lose out because the don't have access to Professional Advice. Conservative Governments have historically made the tax system more complicated this barring the poor from accessing advantageous routes to saving tax.

I agree that the tax system needs to be a lot more simple but ''straight line taxes'' as you propose makes things difficult for ''middle earners'' - In that category, you have ''key workers'' like Nurses and Teachers. If you overtax them it can then be difficult to recruit them in places like London where the cost of living is so high because they can't afford accommodation.

HMRC are improving in that they are moving ''manpower'' to crack down on ''Tax Avoidance'', which is very welcome but the only way to do that is to remove as many reliefs and tax breaks as possible.

Make any claims to reliefs and benefits retrospective like they do in the US where it encourages them to be claimed by the less well off. OK I concede that will cause Hardship for them for 12 to 18 months but after that they would get tax refunds which would then bail them out of the Hardship or at least help alleviate it by having it paid back in terms of refunds.

That won't help people in the long term benefits system I know and I don't have a solution to that off the top of my head for people who can't work but I am sure someone more forward thinking than me could come up with a solution to that.

None of these proposals will please everyone but for me the rich don't need help because they pay for others to help them retain their wealth

Ernest said:

The more you earn the MORE you pay, EVERY single persons tax is deducted at source through PAYE and anyone earning over £100k a year should pay at least 60% tax going up by 10% for every £100k earnt till anyone earning more than £500k a year pays 90% tax.
No tax fiddles and EVERYONES salary disclosed publicly every year and the amount of tax paid shown so we know just who is NOT saying their fair share.

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I don't earn that kind of money, but I think your proposal is grossly unfair to those that have worked hard enough and succeeded, or come up with a brilliant product / service. 90% tax is idiotic at best. You won't get that 90% because 100% of those people would leave.

drew said:

Yet after all that you vote for a government that looks after the wealthy!

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Have you seen the alternative!?

Ernest said:

The more you earn the MORE you pay, EVERY single persons tax is deducted at source through PAYE and anyone earning over £100k a year should pay at least 60% tax going up by 10% for every £100k earnt till anyone earning more than £500k a year pays 90% tax.
No tax fiddles and EVERYONES salary disclosed publicly every year and the amount of tax paid shown so we know just who is NOT saying their fair share.

Click to expand...

That's a Loony Left policy which has been proven as ineffective. Remember the ultra high taxation in the 70's? The government then took more in income tax are slashing the rates!

If we were to tax at those levels again, no one would bother to start a business and any skilled person or those currently earning (and contributing) would simply move overseas.

NooBHA said:

You seem to have covered every tax saving scheme being utilised by every ''Owner Managed Company Director'' currently in existence except the ''Salary Sacrifice'' to qualify for ''Child CarePayments'' (Not Child Benefit) - One parent claiming for one child and second parent doing it for the second childwhich exempts those payments from NIC Employee and Employers if they have their own company.

Therein lies the problem - Only the people who can afford Accountants know about such reliefs so the poorest in society always lose out because the don't have access to Professional Advice. Conservative Governments have historically made the tax system more complicated this barring.way to do that is to remove as many reliefs and tax breaks as possible.

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Not sure I agree. Everyone is being educated about the biggest releif of all - Pensions. With Auto enrollement more than ever are utilising this relief, and that's a good thing.

As for utilising reliefs as an owner managed company director (which you have correctly identified I am) I make use of no reliefs that are not available to those on a PAYE salary.

I remember the good times said:

#Kingcole Can I pick your brain a minute. Self employed earning £40K plus I employ my Wife who is on £20K thus keeping me below that high earner mark. I do my own books but get an accountant to check them off with an official looking document. Can you explain the pension bit for me and whether I should be paying into a scheme and claiming back tax. I'm 60 but will be working (an income) at least another 10 years.

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The obvious answer is you should seek advice from an IFA or an accountant.

But, the rules as they stand are that if you are earning £40,000 then you could put all of that into a pension. You could open a SIPP and choose your level of risk. Assuming you have no other reliefs and forgetting the NI for a moment. If you say earned £40k, after your personal allowance you would pay tax at 20% on the remainder, so £5880. If you made a pension contribution of £29400 your effective earnings would be £10600 and you would have no income tax to pay.

As you are over 55, there is nothing stopping you taking the money out your pension right away (although you will be taxed on it). The first 25% of what you take out is tax free.

I think the rules change if you have already made drawings from a pension, but again, a question for a pro advisor.

I manage my own pension via a SIPP. All very strightforward

Penalising moderately successful people (earning up to say £300-k-£500k p.a) through excessive taxation doesn't work. This leads to avoidance measures. It has been proven that a fair (and I would agree, a simple) tax structure can actually increase the tax take.

The real issue is the lack of international co-operation on tax havens and companies moving profits to low taxation countries.

This, IMO, is where vast amounts of extra government revenue could be obtained - not by penalising companies/the elite, but by ensuring they pay fair taxation.

Also, using the "tax savings" amounts is misleading too. This could be compared in another way. For example:

In a flat tax situation with a single rate of 30% and a threshold of £10k, Joe earns £20k, so pays £3k tax which equates to 15% of his salary.
Fred, earns £100k, so pays £27k, rate equates to 27%.

If you have progressive rates, then assume at £50k the rate increases to 40%, under these conditions Fred would pay £32k tax, which equates to 32%.

Personally I feel that once tax rates get above 40%, then something is wrong.

kingcole said:

That's a Loony Left policy which has been proven as ineffective. Remember the ultra high taxation in the 70's? The government then took more in income tax are slashing the rates!

If we were to tax at those levels again, no one would bother to start a business and any skilled person or those currently earning (and contributing) would simply move overseas.

Click to expand...

Don't let the door hit your backside on the way out, anyone who is prepared not to pay their fare share should be kicked out anyway

NooBHA said:

Therein lies the problem - Only the people who can afford Accountants know about such reliefs so the poorest in society always lose out because the don't have access to Professional Advice. Conservative Governments have historically made the tax system more complicated this barring the poor from accessing advantageous routes to saving tax.

Click to expand...

this isnt true. for a start, the poorest arent paying income tax at all. secondly Brown was responsible for all manner of tax reliefs avilable to middle-high income earners, and more than doubled the amount of tax legislation.

get the politics out of the way, do we want tax to pay for public services or to punish those that have been succesfful in careers? if we assume the former, the politics should be about how much we spend on the services and what they are, then use a simple tax system, adjusted a few % either way to pay for it.

Ernest said:

Don't let the door hit your backside on the way out, anyone who is prepared not to pay their fare share should be kicked out anyway

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I agree (a bit) with your viewpoint that those not paying their fair share should be penalised. However, I would suggest that someone who earns a lot are paying their fair share. Our of interest, someone earning £250k a year would be paying well over £100k in taxes. Is this a fair share and if not, how much do you think they should pay?

I think it's wrong that such a person could save over £70,000 in tax if they utilised their pension reliefs to the max, but that was what I was highlighting as unfair in my original post.

For the record, what I regard as very unfair is the exploitation of the low paid to contribute to Unions from a salary on which they may just about be managing. They may as well set up a standing order to the North Korean totalitarian government. At least they would not have advised to ditch a £2000 bonus and fight something that will clearly happen eventually anyhow

Leaving the inevitable arguments about tax AMOUNTS, I totally agree that the tax STRUCTURE is ridiculously confusing. I agree there is no reason to separate NI from income tax as they're BOTH income tax.

The same thing for tax credits. What bureaucratic moron thought it more sensible to tax someone then refund them (via a different process) than just not to tax them in the first place? It's absolutely mad.

yxee said:

Leaving the inevitable arguments about tax AMOUNTS, I totally agree that the tax STRUCTURE is ridiculously confusing. I agree there is no reason to separate NI from income tax as they're BOTH income tax.

The same thing for tax credits. What bureaucratic moron thought it more sensible to tax someone then refund them (via a different process) than just not to tax them in the first place? It's absolutely mad.

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This. The amount of tax and the thresholds will be determined by the government in power and the shape of the economy at the time. The current complexity is unnecessary, helps no one

kingcole said:

Not sure I agree. Everyone is being educated about the biggest releif of all - Pensions. With Auto enrollement more than ever are utilising this relief, and that's a good thing.

As for utilising reliefs as an owner managed company director (which you have correctly identified I am) I make use of no reliefs that are not available to those on a PAYE salary.

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WOW - Not even the replacement of salary with dividends ? Very commendable. I salute you then Sir

yxee said:

Leaving the inevitable arguments about tax AMOUNTS, I totally agree that the tax STRUCTURE is ridiculously confusing. I agree there is no reason to separate NI from income tax as they're BOTH income tax.
The same thing for tax credits. What bureaucratic moron thought it more sensible to tax someone then refund them (via a different process) than just not to tax them in the first place? It's absolutely mad.

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That is something which will happen in time. HMRC have consulted on this on many occasions in the last 20 years and the assessing of Class 2 NIC under the Self Assessment system for Self Employed taxpayers started to happen from 2015/16 onwards.

They can't bring this in overnight because it will overload the State Pension Entitlement calculations for people who already qualify under the old Class 2 system. So before they can abolish it they need to come up with a way of calculating peoples entitlement to date, which I can see them doing in the next 8 to 10 years. They then need to come up with a plan on how to change over. A bit like they did when they were implementing both ''Independent Taxation'' in the early 1990s and the Self Assessment system itself.