Page last updated at 17:35 GMT, Tuesday, 13 May 2008 18:35 UK

Q&A: Tax changes

Alistair Darling
The changes were announced in the Commons on 13 May

The government is coming under fresh pressure to compensate the 1.1m people who are still worse off, after the abolition of the 10p tax rate.

Chancellor Alistair Darling announced changes in May to the personal allowance in a bid to defuse the row over the abolition of the 10p tax rate - estimated to have hit 5.3m households.

It meant more money for several million people paying the basic tax rate, but about 1.1m were still worse off.

Some Labour MPs say the government should compensate them during this financial year. The chancellor has said he wants to do more to help them in the autumn pre-Budget report.

How did the row come about?

A series of tax changes came in at the start of the financial year, on 6 April. They had been announced in Gordon Brown's final Budget as chancellor in 2007 and in the later pre-Budget report.

The changes saw the 10% starter rate of income tax abolished, except on savings income for people who are low paid. The basic tax rate came down to 20% from 22%.

When 5.3 million people realised this meant less money in their pocket, many spoke out leading to a backbench rebellion by Labour MPs.

What changes were announced by the chancellor in May?

Alistair Darling said he wanted to compensate the people who lost out.

He is borrowing 2.7bn to raise personal tax allowance by 600 to 6,035.

This means anyone earning up to about 40,835 will gain 120 this year.

Mr Darling said 4.2 million of those households which lost out previously will receive as much or more than they lost when the 10p starting rate of tax was axed, and the remaining 1.1m households will see their loss at least halved.

The biggest losers, experts say, would be some of the very lowest earners who do not have families and do not work enough hours to claim tax credits.

What is my personal allowance?

The personal allowance means you earn a certain amount of income without paying any tax at all. Income tax starts being paid on earnings above this amount.

Personal allowances are amended each year in the Budget, and usually they go up with inflation.

In the current tax year 2008/2009 the basic personal allowance was set at 5,435 (up from 5,225 the previous year) but has now gone up by 600, a rise backdated until 6 April.

People can expect a 60 lump sum in September pay packets, followed by a 10 monthly increase until the end of the year.

The chancellor's announcement was extremely unusual as it made changes to the tax system after the Budget - a move not seen by a chancellor for around 15 years.

Won't the better off gain too?

Around 17 million middle-income earners, who did not lose out when the 10p rate was axed, will gain from what the Institute of Fiscal Studies (IFS) described as a "simple and expensive option".

Extra money for these people makes up around 2bn of the 2.7bn handout, the IFS says.

Mr Darling said he would lower the starting point at which the 40p tax band is paid by 600 to 40,835, so the most well-off would not gain more.

This will push 150,000 people into the higher 40p tax rate but the Treasury said that these people would still benefit from the extra 120 this year.

It remains to be seen what will happen next year, as all these changes are for this year only.

It also remains to be seen whether this move - which will give millions of people a little more spending power - will cut the chances of a fall in interest rates in the coming months.

What does it mean for people running small businesses?

While many low and middle income earners will gain, there are some issues to deal with for those who pay them.

Chas Roy-Chowdhury, head of taxation at the Association of Chartered Accountants, said businesses systems and processes will have to be updated halfway through the tax year in September.

"SMEs represent over 99% of UK businesses, and they will have to change their PAYE codes and tax systems," he said.

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