The loss of tax reliefs and successive governments’ failure to raise upper tax thresholds are behind a dramatic increase in the proportion of Britain’s total tax paid by just a minority of high earners, an analysis of tax receipts shows.
There are fears that in his Budget on Wednesday Philip Hammond will rely further on this “tax creep” as a surreptitious means to bolster revenues. Many expect him to go further and follow the trend set by his predecessor, George Osborne, in reducing tax perks for the better off.
Between 2010 and this tax year the number of higher-rate taxpayers has jumped from three million to 4.2 million, despite a modest increase in the higher-rate threshold that took effect in April. The number of additional-rate taxpayers – those who earn more than the £150,000 threshold – rose from 236,000 to 364,000.
The number of seriously high earners, on more than £250,000, has risen from 100,700 in 2010-11 to 137,300 in 2014-15, the last year data is available.
Meanwhile at the bottom end of the income scale millions of people have dropped out of the tax net altogether, as a result of dramatic increases in the personal allowance. This means the highest 1pc of earners now contribute almost 30pc of tax – while the bottom 50pc of all earners contribute less than 10pc.
A number of disjointed measures over the years have also made the tax system complicated to navigate for higher earners – with consequences that are only now beginning to become clear.
This sets a precedent, savings experts warn.
Sir Steve Webb, former pensions minister and now a director at Royal London, the mutual insurer, said: “If you are Philip Hammond what you are looking for is complicated measures that no one understands and that affect relatively high earners.”
Like others, he predicted a further reduction in the amount higher earners can save in pensions while attracting tax relief.
The “annual allowance” for pensions is £40,000, but new rules introduced in 2016 limit this for higher earners.
The reduction in annual allowance occurs on a sliding scale, with individuals losing £1 of their allowance for every £2 by which their earnings exceed the £150,000 threshold.
When earnings reach £210,000 the annual allowance is cut to £10,000. This means that each individual’s annual allowance is different.
The rules, known as “taper rules”, are so complicated that even professional advisers struggle.
“No one will march down Whitehall to object to a change in the taper for the annual allowance,” Sir Steve said.
“If he changed the £150,000 limit to £125,000 I would guess he would raise about £250m in revenue. He will get that through on the nod, the opposition won’t vote against it and it will raise a bit of money.”
But the way the rules work mean staff on lower salaries can lose out too.
Because employers are anxious about accidentally breaching the rules, many are cutting back on pension contributions when workers earn a far smaller sum than £150,000.
Tim Holmes of Salisbury House Wealth, a financial adviser, said: “Limiting pension savings to £10,000 a year for those earnings over £210,000 can deal a big blow to young professionals who succeed early on in their careers.
“It can mean that they struggle to save enough to maintain their standard of living in later life – especially if they depend on their pension savings alone.
“As the economy continues to recover – and as more and more young people choose to start up their own companies – young high earners could increase considerably in numbers over the coming years.”
Sir Steve said: “The point of a pension is to make sure your living standard doesn’t slump when you stop earning. If you can’t save a significant proportion of earnings you are going to see a big drop in your standard of living in retirement.”
His rule of thumb is that every £1,000 you put in a pension turns into roughly £1 a week in retirement income. This means that a £10,000 allowance adds only £10 a week to pension income each year.
While some might dismiss this as a problem only for the very rich, Sir Steve said that because the earnings “threshold” figure for calculating the allowance included all wages, any other income and the money your employer put into the pension, it could hit many people.
“I think it’s pretty prevalent that companies will not want to work out the actual allowance each employee has and so instead says it’s simpler to just reduce the allowance to £10,000,” he added. “That pushes more people out of pensions and so they end up investing in property and other assets.”
Many higher earners are only just realising that they have fallen foul of the rules, said Claire Trott of Technical Connection, a tax specialist.
“Pension saving statements have only gone out in the past month for the last tax year, so people are only just realising that they have been caught out,” she said.
Many others are caught as their bonuses are not paid until the end of March, meaning they don’t actually know what their earnings will be until the end of the tax year, Ms Trott added.
She said she expected Mr Hammond to lower the income limits again, and so trap more people in the net.
“I live in hope the rules will be changed. It’s currently a completely unworkable policy. But I fear the threshold will come down again.”