The value of investments and any income from them can fall and you may get back less than you invested.

Taxing the 5%

The shadow chancellor has said that the Labour Party would finance its policies by increasing income tax on the top 5% if it were to win the election. So how do the numbers stack up?

Labour’s tax plans, as revealed so far, are that those earning £80,000 and above would pay more income tax, although how much more has not been specified. This is a jump from the £70,000 threshold which shadow chancellor John McDonnell had previously suggested would catch the top 5% of taxpayers. The actual numbers from HMRC and the Office for National Statistics suggest that around £80,000 is roughly the cut off for the top 5% of earners.

  • The HMRC data says that back in 2014/15 a total income (not just earnings) of £71,700 was required to hit the 95% threshold, but unfortunately this is the latest HMRC data, published two months ago.
  • The most recent Annual Survey of Hours and Earnings (ASHE) data from the ONS show that the top 5% of earners saw income rise by 2.5% in 2015/16 (against a median increase of 2.2%). For 2016/17, the earnings change is likely to be very similar the median year-on-year figure was 2.3% in February. So if we add say 7.5% to the HMRC figure to cover three years’ wage increases, the 2017/18 95% threshold comes out at £77,200 in round numbers. If you then assume that any McDonnell income tax changes take effect from 2018/19, then £80,000 looks very close to the likely top 5% threshold.

BUT HOW MUCH DIFFERENCE WILL THIS REALLY MAKE? 

  • In 2014/15, 30.7m income taxpayers supplied £167bn to the Exchequer. That was about 28% of total Exchequer income, underlining why a promise to freeze income tax rates is a folly in most economists’ eyes. The 1.61m people (5.24%) with income of £70,000 and above handed over £80.19bn – 48% of the total income tax paid. So the top 5% already effectively pay half of all income tax.
  • It is at this point that the maths becomes foggy. We do not know how much more tax Labour would want to raise or how much they would spend. The two numbers are not the same as McDonnell has made clear he would increase borrowing to fund capital expenditure. What we can say is that adding a tenth to the income tax bill of the top 5% could raise about £9bn by 2018/19. This is not a huge amount when public sector current expenditure for that year is forecast by the OBR (on today’s policies) to be £730.9bn. The same £9bn could be raised by adding 2p to basic rate or 1% to the employee and employer Class 1 NIC rates.

In practice a tax change at the top end will likely be accompanied by significant behavioral effects and may not deliver the anticipated cash flows to the Exchequer. The introduction (and subsequent reduction) in the additional rate income tax and dividend tax changes have highlighted this distorting effect.

The top 5% of taxpayers are the people most likely to be able to manipulate how and when (or even if) they receive their income. Again, the dividend changes provide an example: HMRC estimate that the pre-announcement of the dividend reform cost the Exchequer £0.8bn, of which £110m went to just 100 individuals, drawing an average pre-emptive dividend of £30m.

“Taxing the rich” appears to work on the same principle as the wisdom of robbing banks – that’s where the money is. However, as with bank robbery, knowing where the money is will usually be very much easier than extracting it.

Please note that this document was prepared by a third party and as such Brewin Dolphin is not responsible for the content or able to answer queries on the topics dealt with. While we believe it to be correct at the time of writing, Brewin Dolphin is not a tax adviser and tax law is subject to frequent change. Therefore you should not rely on this information without seeking professional advice from a qualified tax adviser, who should also be able to assist you with any questions on the content.

This document was prepared as a general guide only and does not constitute tax or legal advice.

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