Page last updated at 08:40 GMT, Friday, 18 December 2009

How Darling will tax the rich until their pips squeak

By Ian Pollock
Personal finance reporter, BBC News

Dennis Healey in 1992
Dennis Healey, former Labour chancellor

It is now 36 years since the chancellor Dennis Healey told a Labour Party conference that there would be "howls of anguish" from people who were rich enough to pay more than 75% tax on their last slice of earnings.

In the popular mind this merged with a similar threat he made the following year when he said he would "squeeze property speculators until the pips squeak".

Now, about 300,000 of the highest earners in the UK have just over a year to get used to the idea that Chancellor Alistair Darling is having another go, with four separate changes to their taxes.

The changes were announced earlier this year in the Budget and are expected to raise about £7.5bn a year by 2012-13, according to Treasury estimates.

Details of what may be the biggest change, to pension tax relief, were finally published in a consultation document issued as part of the recent pre-Budget report.

For the first time individuals whose gross income is more than £150,000 a year will be taxed on the value of their employers' pension contributions.

On top of the other forthcoming changes, some of which start next year, high earners at this level will eventually have to pay an average of £20,000 a year each in extra taxes.

The changes

From April 2010 a new higher tax rate of 50% will be applied to incomes over £150,000 a year, as previously announced. This will raise about £2.4bn by 2011-12.

Who earns more than 150,000?
300,000 people
1% of working age taxpayers
They receive 25% of all pension tax relief
About half live in London and South East
About 90% are men
About 55% work in financial services, real estate and business services
80% are in the private sector
45% are in employer DC schemes
37% are in employer final-salary schemes
Source: HM Treasury

At the same time, once someone's income rises above £100,000 a year, they will gradually lose all of their personal income tax allowance, which currently shields the first £6,475 of everyone's income from tax.

This allowance will be phased out totally once earnings reach £112,950 and will raise a further £1.5bn for the government's coffers, according to Treasury estimates.

But a year later, from April 2011, the top slice of incomes above £150,000 will be taxed even more.

Tax relief on peoples' own pension contributions will be steadily reduced, dropping from a 50% rate at £150,000 to just the basic rate of 20% at £180,000 a year or more.

And on top of that these people will have to pay as much as 30% tax on the value of the pension contributions made by their employer.

Those increases will add a further £3.6bn to the collective tax bill of these high earners by 2012-13.

Doing the maths

John Whiting, of the Chartered Institute of Taxation (CIOT), has calculated the sort of extra tax bill some individuals will face.

Take someone who earns £200,000 a year and who makes £20,000 of contributions to their pension scheme, which are matched by identical contributions from their employer.

In the current tax year 2009-10 their total tax bill, including national insurance contributions (NICs) will come to £67,689.

By 2011-12 they will have to pay more as follows:

• Tax on employer contributions: 30% on £20,000 = £6,000

• Tax relief on own pension contributions reduced by = £4,000

• Personal allowance lost = £2,590

• Impact of 50% tax rate = £5,000

• NICs: 1% extra on £194,285 = £1,943

• NICs: increase in start point = £91 saved

• Total extra tax = £19,442.

That is a whopping increase in that person's tax bill of 29%, to £87,131.

Huge change

Taxing employers' pension contributions as a benefit-in-kind is a dramatic change in official pension policy.

The number of people affected could increase significantly over time - perhaps more than doubling over the next ten years
Mick Calvert, Watson Wyatt

The government has a sound reason for this, other than just wanting to levy more tax on high earners.

It realised that its forthcoming 50% top rate of income tax meant that the high earners would also automatically receive 50% tax relief on their own pension contributions.

The current system of pension tax relief means that for every pound they paid into their pension funds they would be able to knock one pound off their taxable income, and thus save 50p in tax.

So the government is tapering their pension tax relief from 50% to 20% to stop that happening, and to stop the highest paid hoovering up even more of the tax relief given to pension savers.

In the past three years the cash value of all pension tax relief has shot up.

Higher rate tax payers gained 65% of the £28.4bn tax foregone in 2008-09, even though they comprised only 19% of pension savers.

In fact those people earning more than £150,000 a year now gain 25% of all pension tax relief, worth an average of £20,000 a year each.

The government is also afraid that cunning higher earners would avoid the new 50% tax rate by asking their employers to cut their pay to below £150,000, but getting them to pay the difference into their pension schemes instead.

The details of the new pension tax regime in the 115-page consultation document make one thing very clear - the plans add up to one of the most complicated changes to the UK tax system yet seen.

And Mick Calvert at the pension advisors Watson Wyatt says many more people could be affected in due course.

"There is no provision in the proposals for indexation of the income thresholds," he points out.

"Without such a measure the number of people affected could increase significantly over time - perhaps more than doubling over the next ten years."

In the second part of his explanation of the government's plans for taxing the rich, Ian Pollock will look in more detail at the taxation of pension contributions.

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