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Budget 2001


Income Tax Personal Allowances

The personal allowance is deducted from an individual's total pre-tax income in order to derive their taxable income. Taxpayers under 65 years old receive a personal allowance which at present is £4,535 (this is the pre-announced value from April of 2001). For example, iftotal income is £10,000 then taxable income is £5,465 (£10,000- £4,535). 

Persons aged 65 to 74 receive a higher personal allowance of £5,990, while those aged over 75 are entitled to an allowance of £6,260However, if income exceeds a certain limit known as the "income limit forage related allowances" (£17,600) then the over 65 allowancesare reduced. 

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Income Tax Rates

Different tax rates are applied to taxable income depending upon the "tax band" that income falls within. From April 2001, the first £1,580 of taxable incomeis taxed at the "lower rate" of taxation which is presently 20%, the next£27,820 is calculated at 23%, the "basic rate". All taxable incomeabove this ceiling which is known as the "basic rate limit" ie, over £29,400,is taxed at the higher rate of 40%. The rate at which any extra earnedincome is taxed is known as the "marginal rate" of taxation. 

Tax Rates and Bands
Taxable income per year (£)
Rate of tax(%)
0 - 1,580 (Lower rate band) 10%
1581- 29,400 (Basic rate band) 22%
Over 29,400 (Higher rate band) 40%

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Indexation Provisions

In the budget, the Chancellor normally increases the tax allowances andbands to allow for inflation.
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Examples of Income Tax Calculations

The following examples show how bills are determined under the currentincome tax system.
  1. A person earning £3,000 per year.
    The personal allowance is £4,535 so no income tax is paid. 

  2. A single person on an income of £15,000 per year .
    The personal allowance is £4,535 so taxable income is £10,465. The lower rate of income tax, 10%, is paid on the first £1,580 (£158) and 22% on the remaining £8,885 (£1,954.70p) giving a totalincome tax bill of £2,1127 (£158 + £1,954.70p). 

  3. A married person with an income of £42,150 per year.
    Taxableincome is £37,615 (£42,150 less the personal allowance of £4,535),of which £1,580 is taxed at 10% (£158) and the next £27,820 at 22% (£6120.40p). The remaining £8,215 is taxed at the higherrate of 40% (£3,286).
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National Insurance

Payment of National Insurance (NI) contributions entitles individuals toreceipt of certain social security benefits, of which the state retirementpension is the most important. Although payment confers entitlement, NIcontributions paid by today's workers actually pay the benefits of today'sunemployed, pensioners and so on. They are not invested for the future.In order to facilitate this it is necessary to maintain a pool of resources,known as the NI fund. Note that the NI fund does not operate in the sameway as a private pension or insurance fund. In the NI system current contributionsfinance current benefit payments with the fund merely being a device toprevent cash flow problems.

The fund officially should not fall below one sixth of NI expenditure for that year. Historically this has been achieved through a grant fromcentral taxation, because contributions paid into the fund were not enoughto meet benefits paid out. The high level of economic activity in the mid-1980swhich expanded contribution levels allowed the grant to be abolished in1990. However the recession which followed reduced contributions and substantiallyraised the costs of benefits so that the grant had to be re-introducedfor 1993-94.

For the year 2000/1, NI contributions are expected to raise about £60billion. About 95% of the income raised is from Class 1 contributions whichare paid by two groups, employees as a tax on their earnings, and by employersas secondary contributions on those they employ. Since 1975 NI contributions from both employers and employees have been earnings related subject toan earnings floor, with a maximum premium for employees. The remaining5% of income raised comes mainly from the self-employed (Class 2 and Class4 contributions), with voluntary contributions (Class 3) making up about0.1% of the total. 

Our model allows changes to employees NI only.

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Employees' Contributions

Employees pay a NI contribution if their weekly earnings exceed the "lower earnings limit" (LEL) which is currently £87. The rate is 10% for those in the State Earnings-Related Pension Scheme. The Upper Earnings limit is currently £575 p.w., above which no extra contributions are made.
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Employers' Contributions

Employers also pay NI contributions for each of their employees who earns over the LEL.. Unlike employee contributions there is no maximum limitso contributions increase even when wages exceed the UEL.
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Contracting Out

Payment of NI contributions entitles the employee to numerous benefits.One such benefit is the state earnings related pension scheme (SERPS) whichis an earnings related addition to the basic retirement pension. However,if an employer has an eligible pension scheme then their employees canbe contracted out of the state system into the employer's scheme. Suchcontracting out means that the employee is no longer entitled to receivea SERPS pension on retirement and their NI contributions are reduced accordingly.The reduction in NI contributions occurs to the percentage levied on theearnings between the LEL and the UEL which falls from 10% to 8.4%. Thesecondary contributions by the employer for a contracted out employee arealso lowered, currently by 3% between the LEL and the UEL.

Additionally, individual employees not contracted out into an employer's scheme can arrange for the SERPS component of their NI contribution tobe directed into an approved personal pension fund. In this case the employee and the employer still pay the normal NI contributions applying to thosenot contracted out, but at the year end a rebate is paid by the Exchequerinto the employee's personal pension fund. The rebate is the differencebetween the NI contributions actually paid by both the employer and theemployee and the amount they would have paid had the employee been contractedout into an employer's pension scheme. Also if the employee is over 30years old, a "sweetener" of 1% of earnings above the LEL and below theUEL is added to the rebate.

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Value Added Tax

The IFS estimates that value added tax (VAT) will raise £59 billion in 1998-99. The standard rate of VAT is currently 17.5%. However, VAT ischarged at 5% on domestic fuel (reduced from 8% at the 1997 budget). 

Firms pay VAT on their sales but claim back the tax implicit in thecosts of their inputs. Therefore, the net tax paid is on the "value added" by the firm to the good or service, that is, the difference between thesum of the prices they paid for materials and other inputs, and the pricethey charge for the final good or service.

Zero-Rated Goods

Approximately 25% of consumer spending is on zero-rated goods. Zero-rated goods are treated in the same way as standard-rate goods, except that a0% rate of VAT is paid by firms on their inputs and charged on their finalgoods. Currently the most important zero-rated goods are:
  • Most food (not alcohol, soft drinks, confectionery and crisps and mealsout)
  • Construction of new dwellings
  • Passenger transport
  • Books, newspapers and magazines
  • Medicines on prescription
  • Children's clothing

VAT-exempt Goods

About 15% of consumer expenditure is on VAT-exempt goods. With such goods firms cannot reclaim the VAT they pay on inputs, but no VAT is chargedon the final good sold to the consumer. The effect of this is that a lowertax rate is levied on these goods. The main VAT-exempt goods are:
  • Rents
  • Private education
  • Health Services
  • Postal services
  • Finance and insurance
  • Burial and cremation
It should be noted that VAT is not levied on any exports but is chargedon imports.

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Excise Duties

The five major goods that excise duties are levied on are, beer, wine,spirits, tobacco and petrol. The IFS estimates that these duties will raise£36 billion in 1998-99.

Excise duties are charged at a fixed level in cash terms for units ofa good (packets of 20 cigarettes, pint of beer and so on). Taxes of this sort are know as specific duties. Tobacco is subject to an additional ad valorem tax of 21% on the total retail price including duty.

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Vehicle Excise Duty

Vehicle excise duty (VED), otherwise known as "road tax" is an annual duty payable by motorists and motorcyclists on each vehicle they own. On commercial vehicles it is charged according to axle weight.

Until June 1999, VED was levied at a fixed rate per vehicle, but the structure was changed in the 1999 Budget to include a lower rate for small cars. In the March 2000 Budget, further changes to the system were announced, which will come into effect from March 2001. First, the small-car threshold was increased from 1,100cc to 1,200cc and, second, a new system of graduated VED for new cars was introduced. This involves placing cars in bands according to their rate of carbon dioxide emissions and charging VED accordingly. This system will apply only to new cars because detailed information about carbon dioxide emission performance is only available for new cars.
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State Benefits

State Benefits in Britain today can be divided into three broad categories:

Means-Tested Benefits

There are three benefits which are given solely to families on low incomes,and which are withdrawn as income rises. All depend on a comparison ofthe needs of a family with it's income. All have similar rules for thecalculation of needs and for what counts as income. The three means-testedbenefits are:

  • Income Support (non-contributory Jobseekers Allowancefor the unemployed)

    This is in effect the state "safety net" benefit. To qualify you mustnot be in full time work (16 hours per week or over). For those who qualify,income is brought up to the level of needs (known as their "applicable amount"). The applicable amount is calculated by adding together personal allowances (basic amounts for each person, chiefly dependent age) and permia (extra amounts for those in special circumstances, such assingle parents or the disabled). The applicable amount for a single personover 25 will be  £53.05p per week from April, whilst for a single parentwith two children aged under 11 it would be 94.85 per week. All income above a small disregard is withdrawn £ for £. 

    Those in receipt of Income Support generally qualify for 100% housingbenefit rent and council tax rebates, and some will have their Mortgage Interest payments met. About £18,000 million will be spent on income support this year.

  • Working Families Tax Credit (WFTC)

    This is a benefit for low income families in full time work (more than16 hours per week). A maximum Family Credit is calculated in much the sameway as under Income Support (but with different values: £106p for ourSingle Parent above). Income is then compared to a threshold (£92.90 from April). If income is less than this, maximum family credit is paid.For incomes greater than this, benefit is withdrawn at a rate of 55p inthe £. For example, if our single parent worked 20 hours per week andearned £100, then she would receive 102.10 in WFTC (£106 maximum less 55% of (£100 - £92.90). 

  • Housing Benefit

    This reduces the rent and council tax of all those on low incomes. Both employed and unemployed are eligible. Needs and Income are calculated in the much the same way as for Income Support. Those with income belowneeds will in most cases have all their rent and council tax paid (rebated).Those with incomes above needs have their rebates reduced at the rate of65p in the £ for rents and 20p in the £ for Council Tax.

National Insurance Benefits

These benefits are paid from the National Insurance Fund, and payable onlyto those who have contributed to the fund. These benefits are not means-tested, but are instead paid to all those who meet a particular contingency, such as being unemployed or retired:

  • Retirement Pension is worth £72.50 per week to a single pensioner and £104.25 per week to a couple There are deductions for those who haven't paid enough National Insurance contributions, andadditions for those who have paid in to the State Earnings Related PensionScheme     (SERPS). About £36 billion willbe paid in state pensions this year. 
  • Contributory Job seeker's allowance replaced Unemployment Benefitin 1996.
  • Incapacity Benefit which replaced Invalidity Benefit in 1995; Formost claimants this is worth £69.75 per week.

Other Benefits

The most important of these is Child Benefit. which is paid to allfamilies with children. Child Benefit is worth £15.50 per week forthe first child and £5.15 per week for each subsequent child.

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Government Spending

Government expenditure in the UK for 1999/2000 is expected to be 349bn. That is:


A lot of money! Seen like this, the importance of government expenditure to the economy is very clear. The government pays for defence, education, social security, health, roads, museums, libraries, the police and courts and.............. All these are vital public services and any changes in the government's spending policies will have a major impact on the economy.

Adjusting the level of government expenditure is a key part of the government's fiscal policy. It is possible to change the level of government expenditure in the model and see the effect both on the macroeconomic targets and on individual families.

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