Income Tax - It's here to stay
Finance

Income Tax: It’s here to stay

The big state versus small state argument is nothing new to Britain, and is usually seen as a battle of political ideologies. Taxation is central to that, with the monies to pay for public services, welfare and infrastructure needing to come from somewhere. And, with a complex and varied system, there are often calls for taxes to be abolished or reformed.

One of the honourable exceptions is income tax. Certainly, there isn't always agreement as to the levels at which the different thresholds should be set, nor the rates that should be levied. But no one in the House of Commons vociferously argues against its existence.

Except, it would seem, maverick Conservative Michael Fabricant, who in a recent interview with This is Money revealed that he would abolish income tax if he were Chancellor of the Exchequer. Admittedly, the Lichfield MP was light-hearted, and acknowledged that this very ideal precluded him from ever becoming Chancellor. But he nonetheless shone a light on the myth that income tax has been an ever-present in British life.

A brief history

Income tax didn't exist until the Budget of 1798, when William Pitt the Younger proposed a levy of two old pence in the pound on incomes of £60+ as a means to fund the Napoleonic Wars. It was initially introduced as a temporary measure, and duly abolished in 1802. A new version of it was then introduced a year later (as was the concept of deduction at source), but abolished again in 1816, following the Battle of Waterloo. 

Yet in 1842, with the Treasury coffers empty and the deficit soaring, newly-elected Conservative Prime Minister Robert Peel reinstated it - despite having campaigned against the tax, which, at the time, was deeply unpopular. However, Peel only levied income tax on the more-affluent (incomes of £150+), and it invariably contributed less than 8 per cent of overall tax revenue in the years that followed. Although the tax remained temporary, given that most people were exempt, no incoming government prioritised abolishing it.

In the 20th century, however, income tax changed dramatically. By the end of the First World War, more people were obliged to pay the standard rate of 30 per cent, while higher earners were liable to pay a 'Surtax' or 'Super Tax'. 

But it was following the Second World War when the Labour Government introduced the welfare state that the net was cast wider, and income tax rates began to soar. The top rate of tax hovered above 90 per cent throughout the 1950s and 60s, and although it was replaced with the Higher Rate of Income Tax in 1973 (set at 83 per cent), the wealthy were still subject to an additional surcharge on investment income of 15 per cent.

Income tax was then slashed during the Margaret Thatcher years. An abrupt cut to the higher rate (to 60 per cent) after her election triumph in 1979 was a sign of things to come, and it was reduced to 40 per cent by 1988. She also cut the basic rate to 25 per cent (from 33 per cent) during her time in office, and this has meandered its way down to 20 per cent in the four decades since.

The present

Income tax actually remains ‘temporary’ to this day, expiring on 5th April each year. Government renews it as part of the annual Finance Bill, although there is a four-month grace period under the Provisional Collection of Taxes Act 1913 during which the Exchequer may continue to collect income tax (allowing time for the Bill to be enshrined into law).

Perception of income tax has also shifted radically, with the new Conservative majority not putting forward any plans to cut rates, and opposition parties even calling for hikes - often to public acclaim. Of course, the rate is not the only policy consideration relating to income tax. Thresholds, and the Personal Allowance directly affect how much income tax we pay. But there is unlikely to be much movement on these fronts until at least 2024.

And the future!

Fabricant's world of zero income tax isn't as far-fetched as it may sound. It's worth noting that, following significant increases to the Personal Allowance in recent years, 43 per cent of UK adults currently aren't liable to pay any income tax (according to the IFS). 

And, in 37 other countries (or territories), it's a reality for 100 per cent of residents. The most high-profile income tax havens are arguably Monaco and the United Arab Emirates (UAE). In the case of the former, tax revenue is instead accumulated through VAT charges (at a rate of 19.6 per cent) and tax on foreign companies. In the UAE, oil revenues and profits earned by public joint-stock companies pay the bulk of the bills.

Although Thatcher had a reputation as a tax cutter, she favoured indirect taxes, and some of these rose, or even came into existence on her watch. Chief among these was VAT, which rocketed from 8 to 15 per cent in the first year of her premiership. Perhaps symbolically, it was the ‘poll tax’ - originally proposed by the Iron Lady during her time as Shadow Environment Secretary in the 1970s - that brought about her downfall when it was implemented in 1989-90.

Nevertheless, indirect taxes provide an alternative template for funding fiscal spending. Britain already has a vast array of these. Although there are six main categories of tax, in reality there are scores of tax revenue sources which support the Exchequer. So it is not inconceivable that these could be ramped up to offset the loss of income tax, were it ever to disappear.

But even if the axe was wielded to the UK's tax system, there are many others which are far more unpopular that would come into the firing line before a glove was laid on income tax. Key to its success is its simplicity and transparency. The progressive nature of the system has an egalitarian element too, which, for the most part, is balanced without being punitive. And there is also a hidden benefit to the majority paying into the pot: it broadens the scope of people with a stake in the welfare state, and incentivises them to preserve it as a result.

Like any tax, it is imperfect, and will always be subject to change. But, given that it is now the highest contributor to overall tax revenue (accounting for just under 31 per cent of the £627.9bn raked in during 2018-19), and public opinion of it sits somewhere between acceptance and embrace, it is likely that income tax will remain at the heart of our tax system for many years to come.

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