When the new 50% top rate of tax and the tapering down of the personal allowance was introduced in April, we knew there would be trouble ahead. As ContractorCalculator reported at the time, the true cost of tax increases goes far beyond the extra pennies in the pound removed from people’s pay packets via the Pay As You Earn (PAYE) scheme. It cost ContractorCalculator many weeks of development time to update our calculators to take account of the additional layer of complexity arising from the tapering down of the personal allowance for those earning between £100,000 and £112,500. And, it seems, this was just the tip of the iceberg.
HMRC’s latest Employer Bulletin includes an innocuous mention that the 2010-2011 tax codes do not take into account the 50% tax rate and that top-rate taxpayers will almost certainly not be paying the correct amount of income tax. This is disingenuous on the part of HMRC, because it only tells half of the story. The crux of the issue is that HMRC could not issue new tax codes because of the tapering down of the personal allowance at £1 for every £2 earned in excess of £100,000 to £112,500. And total earnings might include earnings outside of PAYE, and most earners won’t know what their total earnings are until the end of the tax year.
As a result, and as highlighted in by the Daily Telegraph, many tens of thousands of company directors, professionals and high earners – among them a large number of contractors – who have more than one remunerated position or source of income will be left owing significant amounts of back taxes for the current tax year.
It seems that, rather than tackling the issue head on, completing the necessary calculations and issuing correct codes to individual taxpayers, the Treasury and HMRC chose to ignore this added level of complexity. HMRC never did the sums and no one got updated tax codes that took into account their total earnings, leaving many people with incorrect codes resulting in taxpayers paying too little.
Although the new PAYE IT systems introduced by HMRC can cope with multiple income streams from different jobs and code them correctly, it was not designed to cope with the tapering down of the personal allowance. And, it seems that even these new IT systems designed to cope with this complexity simply cannot – HMRC is currently sending out letters to millions of people who have overpaid or underpaid tax due to incorrect PAYE codes issued by the taxman. There will be some workers not paying the 50% rate of tax, but earning over £100,000 who will still have incorrect tax codes because of the tapering down of the personal allowance.
The tapering down of the personal allowance affecting anyone earning over £100,000 may well end up costing more to administer than it generates in additional tax yield. Self-defeating schemes like this used to be a favourite pastime of a mythical quango I think of as the ‘Office of Tax Complication’. It was particularly busy under Chancellor and then Prime Minister Gordon Brown, when it introduced numerous tax rules that cost more to administer than they raised.
One of those rules, IR35, has been a particularly costly for contractors, with a triple whammy of financial, time and stress-related costs. Fortunately, IR35 and other Office of Tax Complication nightmares are in the coalition government’s sights as potential candidates for simplification.
But the fact remains, we have been left with a higher rate tax legacy that will cost taxpayers, and the economy, much more than the extra pence in the pound it brings in. That is, of course, until George Osborne or a future Chancellor has the courage to repeal it.