The UK income tax system ostensibly gives all income tax payers an identical allowance which exempts the first slice of an individual’s market income from income tax. This exemption is known as the personal allowance and is set by parliament each year. For the current year it stands at £11,500.
Basic Rate (20%) Tax Payers
The personal allowance typically reduces the amount of income tax a basic rate tax payer must pay on their market income by £2,300 pa. However, if a basic rate tax payer’s market income is below £11,500 p.a. they do not receive the full benefit of the annual personal allowance. This is arguably a weakness with the UK’s current income tax arrangements.
Susan earns £10,000 p.a. Her tax-free personal allowance is £11,500 p.a. This means she currently pays no income tax and her disposable income (ignoring her National Insurance Contribution) is £10,000.
If Susan had no personal allowance she would have paid income tax of £2,000 (£10,000 x 20%). The personal allowance has saved Susan £2,000. Had Susan earned £11,500 in the year she would have saved £2,300 in income tax. Because she had only £10,000 of income to offset against her personal allowance of £11,500 Susan has £1,500 of unused personal allowance remaining. In the UK personal allowances can not be carried forward to be utilised in following years. Nor can personal allowances normally be transferred to someone else or be traded – it’s a case of use or lose.
Is there a better way of administering income tax whereby surplus personal allowances would not be wasted if they remain unused at the end of a tax year? An answer to this question is “Yes, negative income tax”.
Negative Income Tax
Giving a taxpayer an annual personal allowance of £11,500 costs the government up to £2,300 in lost tax revenue. In Susan’s case, because her market income is below £11,500, the cost to the government of Susan’s personal allowance is £2,000 in lost tax.
Negative income tax departs from the current income tax system by paying out the value of the personal allowance (the tax shield) in cash to each and every qualifying citizen. To help fund this apparent largesse, income tax would be collected and calculated without reference to personal allowances.
In Susan’s case, income tax of £2,000 would be deducted by her employer and remitted to HMRC. Susan’s net pay from her employer would therefore be £8,000. Susan, along with all qualifying citizens, would receive from HMRC an annual amount equal to the value of her tax shield (£11,500 x 20%) The following table summarises:
At the year end Susan’s income is £300 higher than her gross market income. This £300 is the value of her surplus personal allowance (£1,500 x 20%). So effectively Susan has been allowed to claim back the value of her unused personal allowance as a “refund” from HMRC.
In Susan’s case, HMRC has paid out to Susan £300 more than she has paid to HMRC. So HMRC has a deficit while Susan has a surplus. So how will HMRC fund its deficit?
Firstly, because Susan is on a low income there is a probability that she is on a means tested benefit, such as the dreaded Universal Credit, to augment her low market income. The benefits agency (DWP) may reassess Susan’s financial circumstances and adjust her award to take account of Susan;s additional source of non-market income. So the government may claw back all or part of Susan’s increased income to eliminate its deficit at HMRC.
Secondly, although Susan has a surplus with HMRC, many taxpayers will have a deficit. It is only qualifying citizens with market incomes below £11,500 who will be receiving more from HMRC than they pay in income tax. Many taxpayers will be paying income tax far in excess of the £2,300 they will be receiving each year from HMRC. Deficits and surpluses would offset each other
Purposes of Negative Income Tax
Firstly, to make the income tax system fairer. Currently, those with a market income of above £100,000 do not receive a personal allowance. Introducing a non-means tested negative income tax would enable policy makers to restore the tax shield to high income recipients.
Secondly, to provide an enhancement to low incomes, albeit a modest one.
Thirdly, to give every qualifying citizen a guaranteed, obligation-free income, although a small one. It should help individuals to better absorb and weather the shocks that humans are heir to, including those shocks administered by DWP.
Unlike Universal Basic Income (UBI), the purpose of NIT is not to replace contingent benefits, although some means’tested benefits may be reduced as a consequence of NIT’s introduction.
Every natural person of working age AND registered to vote in UK elections should qualify, irrespective of income. Qualifying individuals would include job seekers, students, disability benefit claimants, employees, self-employed persons, stay-at-home parents, rough sleepers, and prisoners (subject to voting rights). People of state pension age would be excluded.
Summary and Conclusions
The aims of the particular NIT scheme discussed are modest. The scheme is specific to the UK’s income tax system. The scheme provides an opportunity to equalise treatment of different income groups in respect of the operation of personal allowances, otherwise referred to as a tax shield. The parameters of the proposed scheme, that is the NIT rate and the size of the personal allowance, are under the control of the UK parliament and can be altered to suit. The scheme shares features of Basic Income, eg, it is obligation-free, it is not means tested, its coverage is universal (subject to fraud safeguards), and it supports active enfranchisement of disengaged voters. It also provides a small cushion against loss of income and failure of the social security system. Although modest, the benefits would be real and in excess of its costs.
The impact of Negative Income Tax on higher and additional rate taxpayers
Higher Rate (40%) Taxpayers
Stephen has an annual market income of £80,000
Stephen would pay £2,300 more under this particular NIT scheme than he does under the current income tax system. This is because HMRC is paying out at 20% x £11,500 while the lost personal allowance brings in 40% x £11,500 to HMRC. HMRC is in surplus.
Additional Rate (45%) Tax Payers
For annual incomes above £150,000 the income tax rate rises to 45% and no personal allowance is available.
Frances has an annual market income of £170,000
Frances would pay £2,300 less under this particular NIT scheme. This is because in the current income tax regime taxpayers with market incomes above £100,000 have had their personal allowances completely withdrawn. The receipt of NIT of £2,300 from HMRC consequently would reduce tax payable in cases such as this.