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Last Updated: Friday, 20 June, 2003, 13:11 GMT 14:11 UK
Tax bands, a chancellor's best friends

More than 28 million people pay income tax in the UK. The amount of tax one pays is determined both by the rate at which the tax is set and by a series of tax bands and allowances.

This means the government has two means at its disposal for trimming or lifting the amount of tax we pay.

Adjusting tax bands and allowances is a more subtle way of increasing tax-take - but can be just as effective as putting up rates.

Each year, the government announces in the Budget how tax bands and allowances will change.

The key item to watch for is known as "fiscal drag" - a form of backdoor taxation.

Tax bands and allowances (2003/04)
Tax-free personal allowance: 4,615 (under 65s)
10% on taxable income up to 1,960
22% on taxable income between 1,961 and 30,500
40% on taxable income above 30,500

Fiscal drag is when earnings are rising at a faster rate than tax bands and allowances.

In essence, it means more of people's earned income in the forthcoming year will be taxed, and some will move into the higher-rate tax band.

Since 1997, the number of higher-rate tax payers has risen to 3.3 million from 2 million.

A good example was in the recent Budget.

The personal tax free allowance will remain the same as last year, at 4,615 for people under 65.

"We have had it [fiscal drag] in spades this year, with the personal allowance freezing.

"It means a greater proportion of someone's income is being taxed, if we assume people's earnings are increasing," says John Whiting, tax partner at PricewaterhouseCoopers.

Fairer tax?

Some people argue that tax bands should go up in line with earnings, and not prices.

The government has increased tax bands by 2%, based on inflation last September, but earnings are going up faster than that.

In this year's Budget, the threshold at which people pay higher-rate tax went up in line with inflation from 29,900 to 30,500.

This means anyone earning more than 35,115 will pay tax at 40%.

Thousands more people will be brought within the higher-rate tax band.

Stealth taxes

The Labour government has been criticised for exploiting fiscal drag, which critics say is "stealth" taxation.

Tax rate changes
1978/79: Top rate of tax on earned income was 83% on income above 24,000 a year
After 1979 election: Top rate of income tax on earned income dropped to 60% on income over 25,000 a year
1988: Tory chancellor Nigel Lawson introduced top rate of tax at 40%

Source: Grant Thornton

While virtually everyone now knows what a stealth tax is, it is still an effective tool for governments - and especially for one that made a manifesto pledge to not increase income tax.

But income tax bands and allowances are only part of the story.

The other big way governments can increase their tax take is through national insurance.

And the movement of the bands at which we pay NI is similar to backdoor income tax collection.

It has been an effective tool, crafted by the previous Conservative administration, and used to great effect by the current chancellor.

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