- Basic rate tax threshold is £34,500 but it should have been almost £9,500 higher at £44,000 if inflation had been counted in
- Pension contributions and salary sacrifice are ways to reduce tax paid
Middle earners are being penalised by the taxman because the higher rate threshold has not kept up with rising inflation, a new study suggests.
In the current tax year, the higher rate tax threshold is £34,501, a £1,000 increase on last year: which with the standard tax-free allowance of £11,850 means that for most people the 40 per cent rate of tax kicks in at £46,351.
But that would be £9,500 higher at £55,851 if it had gone up in line with prices in recent years, according to calculations by financial advisers Ascot Lloyd.
Income tax: The basic rate threshold has not kept up with the rising cost of living, says report
Prices have risen by about 26 per cent over the last decade, the report says. But the higher rate tax threshold has actually declined by 1 per cent over the same period – from £34,801 in the tax year 2008/09 to £34,501 this year.
Assuming that wages have risen in line with inflation, this process – sometimes referred to as fiscal drag – means that more and more workers are pulled into the higher rate tax band.
The latest estimates show that 25.1million (81.8 per cent of taxpayers) are paying tax at the basic rate. A further 4.2million individuals (13.7% of taxpayers) pay tax at the higher 40 per cent rate.
An estimated 364,000 people are paying the 45p rate of tax on income over £150,000.
‘[…] with inflation adjustment there is a possibility you could earn up to £55,850 and remain a basic rate tax payer. However, under the actual allowances and thresholds the most you could earn and remain as a basic rate taxpayer is £46,350,’ the study says.
Had the basic rate threshold kept up with inflation it would be almost £9,500 higher at £44,000 for 2018/19, according to the report
This means that people earning between £46,351 and £55,850 are effectively paying more tax than they should, according to Sheetal Radia, the author of the report.
Radia highlights that changes to allowances thresholds have not taken into consideration the rising cost of living, but said pension contributions and salary sacrifice are a couple of ways for people affected to reduce the amount of tax they pay.
‘It can be difficult to get your head around taxes, and how you can reduce your tax liability but there are some simple steps which can be taken to reduce the amount of tax you pay from your salary,’ Mr Radia said.
‘One of the most common ways to reduce your tax liability is by making pension contributions or undertaking some form of salary sacrifice. This presumes that you have the ability to make pension contributions.’
Basic rate tax threshold: Over the past decade it has declined by 1 per cent
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