Personal allowances – focusing on lower and middle earners

It is clear from the announcements already made that the significant increases in personal allowances planned by the government will be targeted at low and middle earners, rather than all taxpayers. So any increase in the personal allowance would need to be offset by reductions in the higher and additional rate thresholds, so that high earning taxpayers do not benefit from the changes, which will also make the cost of the measure significantly more manageable. Changes will be made from April next year – the announcement does not contemplate any changes before then, which would be technically impossible in any event.

Increasing personal allowances for all has a variable impact, depending on the income of the taxpayer. With the current thresholds for higher and additional rate (and ignoring the effect of the savings starting rate) the tax saved by increasing personal allowances to £10,000 would be :

  • Income less than £6,475 – Nil
  • Income between £6,475 and £10,000 – the tax due – between £0 and £705
  • Income between £10,000 and £43,875 - £705
  • Income between £43,875 and £100,000 – rising from £705 to £1,410 at £47,400 income

50% taxpayers will not benefit from an increase in personal allowances, as no taxpayer with income above the current limit of £112,950 benefits from a personal allowance due to abatement. If the personal allowance were to increase to £10,000, the maximum abatement would be at £120,000, meaning that the effective 60% tax band would be enlarged from £12,950 to £20,000.

So what would be the likely outcome of the proposals? It is quite clear that no benefit is intended to those on higher incomes, and if we assume that this equates to 40% taxpayers, then an additional £705 in tax needs to be generated by the 40% bracket to eliminate the saving to that taxpayer at the basic rate. This equates to a reduction in the higher rate limit of £1,763, or half of any increase in the personal allowance.

The proposal for the forthcoming Budget would be to make a “substantial” increase in the personal allowance – so let’s assume that there will be an increase of £1,000. This would bring the personal allowance up to £7,475, and require a reduction of £500 in the 40% threshold, reducing it to £36,900. The 60% effective rate band would be charged in the range £100,000 to £114,950.

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