How Labour’s pledge to increase taxes could backfire – analysis from Tilney

With much fanfare, Jeremy Corbyn this week released the Labour Manifesto, with a raft of policies that he hopes will secure a victory in next month’s General Election. One of the key areas announced was an increase in Taxes, with a proposed increase in Income Tax for those earning above £80,000 and another hike for those earning £123,000 or more, along with an increase in Corporation Tax to 26%. However, raising tax rates in isolation will not necessarily result in an increased tax take for the Exchequer as those impacted adjust their behaviour. Here Gary Smith, chartered financial planner at Tilney, analyses the impact of these proposed tax increases and identifies some of the potential implications that will result.

“Labour are proposing to aggressively lower the earning limit, from which someone will incur 45% Income Tax, from the current £150,000 threshold to £80,000, and introduce a new 50% Income Tax rate for those earning above £123,000. There is no clear indication as to why the £80,000 level has been selected for the point at which 45% tax rate will be introduced, other than it is claimed that only 5% of the population earn above this amount. It is probably worthwhile highlighting that, as at 01/04/2016, the base salary for a Member of Parliament was £74,962, which is fortuitous to be below this £80,000 level.

“So how would these tax changes affect someone currently earning £150,000, and how much additional tax would they have to pay? The table below compares the current tax regime alongside the proposed system that Labour would adopt. For the purpose of this exercise, I will assume that the Basic Rate tax band remains at £33,500 and that those earning above £123,000 would be entitled to no Personal Allowance.

“Therefore, on the face of it, an individual currently earning £150,000, would incur an increased Income Tax liability of £4,850 if Labour’s proposals were implemented. However, this simply looks at the tax increase in isolation but how would this tax liability be affected if the individual was maximising their pension contributions of £40,000 per tax-year? The table below illustrates how the tax liability would alter:

“In this instance, the increased tax take for the Exchequer would only be £1,175, which is unlikely to be the tax increase that Labour were hoping for when they calculated their increased spending projects in their Manifesto.

“However, what if the individual was not currently making any pension contributions and was subject to the full Income Tax charge of £53,300. In this instance, the individual could avoid any increase in their Income Tax liability by making a gross pension contribution of £16,166.67, as the additional rate tax relief available would be £4,850, thus resulting in a net Income Tax liability of £53,300, which is the current situation. The individual would also receive Basic Rate Income Tax relief (£3,233.33) on the gross pension contribution made, so they would only actually have to contribute £12,933.34. Therefore, in this scenario, rather than Labour increasing the tax take, the Exchequer would actually be £3,233.33 worse off, which is not going to fund Labour’s Manifesto pledges.

“Labour have also announced that they would seek to increase Corporation tax from the current level of 19% up to 26%. I cannot think of a worse time to implement such a change, as the UK seeks to manage its way through Brexit, whilst still making it an attractive location for businesses. Surely, at a time where multi-national companies are already considering moving some of their offices and staff to cities located within the European Union, an increase in Corporation Tax is only likely to encourage these relocations. This is likely to have a negative impact on UK jobs and ultimately reduce the Income Tax generated to the Exchequer.

“However, it is not just large multi-national companies that will be impacted, what about those small businesses that are often run by one or two directors. An increase in Corporation Tax would potentially reduce the amount that could be paid to staff in increased salaries or bonuses, which would generate Income Tax, not to mention that it would reduce the available capital to reinvest in the business. Directors of businesses could opt to make pension contributions to reduce the impact of the increase in Corporation Tax. Let us assume that a business makes £100,000 profit during the current tax-year, and would be liable to 19% (£19,000) Corporation Tax. Under Labour’s proposed increase, the same level of profits would result in a Corporation Tax liability of £26,000. However, if the business decided to contribute £27,000 into a pension for the director, then this would be deducted from the profit amount, resulting in reduced profits of £73,000 and tax liability of £19,000 assuming the 26% Corporation Tax rate.

“Ultimately, whilst Labour have produced their Manifesto with the best of intentions, I do not believe that their proposed tax increases, in isolation, will result in generating the required additional revenue to fund some of their wider projects. They would then face the prospect of either having to borrow significantly more than expected, resulting in a far higher National Debt, or making changes to other areas of tax legislation, such as pensions tax relief, to compensate. Such changes could inadvertently affect the 95% of the electorate the Labour is seeking to exclude from its proposed tax increases.”