Will income tax changes (i.e. increases) really help the Government

All eyes are on budget predictions, and how far will Chancellor Alastair Darling veer away from his Pre-Budget Report made last November. He has already hinted strongly that his forecast that the economy would contract by less than 2% in 2009, now looks to be almost double that figure. He also announced during the same report that the government could raise £1.6 billion through introducing an income tax rate rising to 45% on incomes above £150,000, to begin from April 2011. In light of the fact that the Treasury needs to raise income and soon, economic pundits appear to be united and unwavering in their opinion that the increase would be “difficult to avoid”

However they also appear to agree on the fact that the Government’s plans to raise income tax rates are highly unlikely to raise the much needed £1.6 billion, and indeed may create an opposite effect.

According to a recent study, increased taxation may well bring a spiral of tax avoidance and/or people from reducing their taxable income

The report also points out that even if the Treasury has judged the situation correctly in how the UK’s largest earner will respond to the rate increase, the reform is liable to only raise around one third of the desired amount, taking into account the loss indirect tax revenues.

The report goes on to point out that the optimal figure that the Treasury could expect to raise would be around one billion pounds, and only if they raised the tax rate to a flat 54%. Simply by increasing the marginal tax rate on incomes above £150,000 would be around £900 million, and that would require an income tax rate of 54%.

Taking history into account and recent history at that, the Treasury needs look no further than the late 1980s. It was discovered then that the 45% band actually reduced revenue for the Government, albeit slightly. Then as now, imposing a 40% income tax rate was found to be the niche that generates the most revenue.

There are no shortages of ways to reduce the levels of income tax to be paid, with many people turning to working less, contributing more to a tax-free private pension among others. Higher, or some may even say prohibitive tax rates might even lead to migration, especially in these days of global economies, or even earlier retirement. Or a mixture of both.

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Tags: Alastair Darling, British Economy, Budget, Economics, Financial News, Tax, UK Recession