Forecasts suggest that one in three workers could eventually pay higher rate income tax

25 Jul 2014

Forecasts suggest that one in three workers could eventually pay higher rate income tax

Official forecasts suggest that if current trends continue some 10 million people will have been pulled into the higher rate income tax threshold by 2033, according to an analysis by The Telegraph.

The newspaper claims that ‘one in three workers will be a higher rate taxpayer within two decades as the 40p band becomes the “norm” for millions of the middle class’, following the publication of a report by the Office for Budget Responsibility forecasting the medium-term effects of ‘fiscal drag’.

Fiscal drag is the process by which the average tax rate rises if allowances and thresholds are indexed to prices rather than earnings, resulting in more taxpayers’ income falling into higher tax bands. Current Government policy is to uprate tax thresholds and allowances in line with inflation, but because earnings are expected to rise more quickly than prices in the long term, more and more income moves into higher tax bands and the average tax rate rises steadily.

The OBR forecasts estimates the number of people who will pay the higher rates of income tax if the current £41,865 threshold rises in line with inflation. Currently 4.6m people pay the 40p higher rate and 300,000 pay the 45p additional rate for those earning more than £150,000. By 2033 the OBR forecasts 9.2 million people will pay the higher rate and 1.7m the additional rate – more than twice as many as at present.

Furthermore, The Telegraph argues that the OBR forecast is likely to be an underestimate, since the Chancellor has restricted rises in the 40p threshold to below the level of inflation. From this year it will go up by a flat 1% until 2016, well below the current CPI inflation measure.

Chancellor George Osborne has resisted Conservative calls to increase the 40p threshold to take into account the rising incomes of ‘middle class’ workers such as teachers, senior nurses and other professionals not normally regarded as high earners, preferring instead to concentrate on raising the tax-free personal allowance in his Budget statements. This analysis of fiscal drag is likely to give more ammunition to those in the party who want to see the higher rate threshold raised.

Former chancellor Lord Lamont said: ‘For the next parliament, raising the higher rate threshold should be a top objective for a Conservative government. It makes no sense that a rate that Nigel Lawson intended to be for the richest people in the country is now being paid by secretaries and middle management.’

The OBR forecast does offer an alternative path. It calculates that if the higher rate threshold were to rise in line with earnings instead of inflation, 4.6 million fewer people would be dragged into it, in its own words ‘effectively switching off fiscal drag.’

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