Income tax has been making the headlines again lately due to the furore caused by Gordon Brown’s abolition of the 10% tax band in 2008-2009. But just what are these “tax bands” and how do they influence your income-tax bill?
Taxable income can come from a number of sources, including interest earned on savings and dividends received from firms. However, for most people their main source is “income from employment” – a salary. Say a 35-year-old earned a gross (pre-tax) salary of £40,000 during the tax year 2007-2008, which ran from 6 April 2007 to 5 April 2008. How much income tax would an employer have collected via the “pay as you earn” (PAYE) system?
First off, everyone in the UK is entitled to earn some tax-free income via a personal allowance of £5,225 for 2007-2008. So £40,000 – £5,225 is £34,775. This remaining amount is then sliced up into different “bands” and taxed at the appropriate rate. For 2007-2008, this works as follows:
1. The first £2,230 is taxed at 10% (“the starting rate”) = £223
2. The next £32,370 is taxed at 22% (“the basic rate”) = £7,121
3. The remainder, above £34,600 is taxed at 40% (“the higher rate”) = £70
The total tax is therefore £7,414 (£223 + £7,121 + £70). Due to the impact of the personal allowance and the starting and basic rates, the effective income-tax rate is only 18.5% (7,414/40,000), despite the fact that a gross income of £40,000 made the recipient a “higher-rate taxpayer”.
By abolishing the 10% band above for 2008-2009, despite lowering the basic rate from 22% to 20%, Gordon Brown is disproportionately penalising those on lower incomes. For example, a salary of £10,000 attracts an effective income-tax rate of around 9% under the new rules, rather than about 7% under the old – hence the outcry.