Tax change winners and losers

Alistair Darling, Chancellor of the Exchequer, has chosen a simple route to compensate those who were worse off through the abolition of the 10p income tax band.

Lifting the personal allowance - the amount which someone can receive before they pay income tax - by £600 has the merit of being administratively simple.

It means that the average basic rate taxpayer will gain by £120.

But the change will not affect everyone equally.

The starting point is to look at the winners and losers from the tax changes that took effect from the start of the tax year.

Out of pocket

Anyone with income over £17,000 was better off, as they gained more through the 2% cut in the basic rate of income tax than they lost through the abolition of the 10% rate.

"The total by which people were out of pocket has been estimated to be £500m-£1bn"

Indeed, thanks to changes in personal allowances and national insurance contributions (NICs), those in work and earning over £15,500 came out ahead.

Higher allowances for those aged 65 and over, and higher child and working tax credits (CTC and WTC) also compensated many on lower incomes.

That left various groups with lower incomes out of pocket, including:

• those aged under 65 who had stopped working
• workers aged under 25, as WTCs only start at 25 (except for the disabled or single parents)
• and many part-time workers and others without children.

The total by which people were out of pocket has been estimated to be £500m-£1bn.

How to compensate?

There was no easy way to compensate precisely those who had lost out.

There have been suggestions, including from the Low Income Tax Reform Group (LITRG), that an adjustment by HM Revenue & Customs was possible, based on PAYE figures.

Mr Darling rejected this as too complex and administratively expensive.

Instead the personal allowance has now been increased by £600 for this tax year.

The higher personal allowances for those aged 65 and over are not altered.

This gives a flat benefit of £120 to taxpayers who have incomes over £6,035.

No mention was made of NICs so it has to be assumed there is no change to the NIC threshold, which is normally parallel to the income tax personal allowance.

To target the tax cut on what the chancellor referred to as "low and middle incomes", higher rate taxpayers will not benefit.

This will be achieved by cutting the starting point for the 40% tax rate by £600.

Previously, this started at £41,435.

With the increase in personal allowance, it would have started at £42,035; instead it will start at £40,835.

Who gains?

By giving this simple adjustment to the personal allowance, many taxpayers will gain, even though they had not lost from the combined effect of abolishing the 10p tax rate and cutting the basic rate from 22% to 20%.

"Interactions with pension credits and the various linked benefits can also produce odd results"

Someone who earned £27,000 was already in line for an income tax reduction of some £210 compared with last year; they will now get a further £120 cut.

Of those who stood to lose, i.e. those with incomes under £16,500, many will now be better off.

But some - those on the every lowest income - will still be out of pocket.

For example, someone on an income of £8,000 was losing about £170 over the year; they are still £50 worse off.

Interactions with pension credits and the various linked benefits can also produce odd results.

Take a 61-year-old woman, her only income a state pension of £6,650.

Her previous tax liability of £243 brought her net income to £6,407 which meant that she was entitled to claim Pension Credit and so maximum housing benefit and council tax benefit.

Ironically, the reduction of her tax liability to £123, while fully compensating her for the loss of the 10% band, means that with a net income of £6,527 she is no longer entitled to Pension Credit and loses out on linked welfare benefits.

For one year only?

This is apparently a package for this tax year only.

Personal allowances normally go up each year and the £600 increase is almost three times the increase over last year's.

It is not clear whether the increase will simply stay and lead to static personal allowances for the next two or three years or be scaled back.

The state of the public finances may be a factor in what happens next year.

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