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Income Tax Personal AllowancesThe 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 £4,195. For example, if total income is £10,000 then taxable income is £5,805 (£10,000 - £4,195).Persons aged 65 to 74 receive a higher personal allowance of £5,410, while those aged over 75 are entitled to an allowance of £5,600. However, if income exceeds a certain limit known as the "income limit for age related allowances" (currently £16,200) then the over 65 allowances are reduced. Income Tax RatesDifferent tax rates are applied to taxable income depending upon the "tax band" that income falls within. The first £4,300 of taxable income is taxed at the "lower rate" of taxation which is presently 20%, the next £22,800 is calculated at 23%, the "basic rate". All taxable income above this ceiling which is known as the "basic rate limit" ie, over £26,100, is taxed at the higher rate of 40%. The rate at which any extra earned income is taxed is known as the "marginal rate" of taxation.
Married Couple's AllowanceThe married couple's allowance (MCA) is currently £1,900 for under 65s and is restricted to 15%. Over 65s are entitled to higher MCAs. As the name suggests, the MCA is available to all married couples. Another allowance, called the Additional Personal Allowance (APA), is available to lone parents and cohabiting couples with children. The APA works in exactly the same way as the MCA.The MCA can be split between the couple in two ways. Firstly, the total amount can be added to one person's allowance or secondly, it can be split so that each partner receives half. If however there is a disagreement between the couple over the MCA then it is automatically split. The MCA works in the following way. First a person's taxable income is derived, that is, income above the personal allowance only. Next, their tax liability is calculated using the tax rates and bands set out above. Finally, those who are eligible to the MCA have their tax bill reduced by 15% of the MCA's value (i.e. £285 for those under 65). The MCA has been limited to the rate of 15% since April 1995. Restricting the MCA means that its cash value (how much it reduces your tax bill) is equalised for all people recieving the allowance. If allowances are not restricted (such as the Personal Allowance) then even though people received the same size allowance, the cash value of the allowance was not necessarily the same. For example, take two people who both received a married couple's allowance of £1,900 which is unrestricted. This tax allowance will reduce the amount of taxable income that the person has to pay. If the allowance did not exist, the extra taxable income would have been taxed at the person's marginal tax rate. Suppose the first person earned an amount that meant they were liable for the lower rate of 20% only, then the MCA reduced their tax bill by £380 (20% of £1,900). However, if the second person earned enough to pay the higher rate of tax then their income tax bill was reduced by £760 (40% of £1,900). In effect the cash value of the allowance was different for the two people because they paid different rates of tax. Indexation ProvisionsIn the budget, the Chancellor normally increases the tax allowances and bands to allow for inflation.Mortgage Interest ReliefMortgage interest relief at source (MIRAS) reduces the amount of interest mortgage holders have to pay. The relief is currently 10% of the interest payable on the first £30,000 of the mortgage. The ceiling of £30,000 has remained unchanged since 1983, thus the real value of the relief has been eroded over the years.The relief is at source, that is, when the mortgage repayments are made. The mortgage lender is refunded the relief by the Exchequer and they in turn reduce the mortgage repayment. Therefore, while MIRAS is technically an income tax relief, it has the effect of reducing mortgage repayments rather than the amount of tax borrowers have to pay. Indeed, borrowers still receive MIRAS even if they have no tax liability at all. In the model, MIRAS is treated as a deduction from income tax liablilty. Since it can be recived by non-taxpayers, this means that in some circumstances income tax liablility will be shown as negative. For example, at an assumed interest rate of 8%, someone with zero tax liablity but a mortgage in excess of 30,000 will be shown as having an income tax liability of -£4.62p.w. (weekly payments of (30,000 x 8%) / 52.0 x 10%). Example of a Reduction in MIRASAssume a person holds a mortgage of £30,000 on which they pay annual interest at 8%. That person faces an annual interest bill of £2,400. However, with MIRAS at 10% the interest repayment is reduced by £240 (10% of £2,400) so that the person only pays £2,160 (£2,400 minus £240) in interest.Examples of Income Tax CalculationsThe following examples show how bills are determined under the current income tax system.
National InsurancePayment of National Insurance (NI) contributions entitles individuals to receipt of certain social security benefits, of which the state retirement pension is the most important. Although payment confers entitlement, NI contributions paid by today's workers actually pay the benefits of today's unemployed, 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 same way as a private pension or insurance fund. In the NI system current contributions finance current benefit payments with the fund merely being a device to prevent 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 from central taxation, because contributions paid into the fund were not enough to meet benefits paid out. The high level of economic activity in the mid-1980s which expanded contribution levels allowed the grant to be abolished in 1990. However the recession which followed reduced contributions and substantially raised the costs of benefits so that the grant had to be re-introduced for 1993-94. For the year 1998-99, NI contributions are expected to raise about £55 billion. About 95% of the income raised is from Class 1 contributions which are paid by two groups, employees as a tax on their earnings, and by employers as secondary contributions on those they employ. Since 1975 NI contributions from both employers and employees have been earnings related subject to an earnings floor, with a maximum premium for employees. The remaining 5% of income raised comes mainly from the self-employed (Class 2 and Class 4 contributions), with voluntary contributions (Class 3) making up about 0.1% of the total. Our model allows changes to employees NI only. Employees' ContributionsEmployees pay a NI contribution if their weekly earnings exceed the "lower earnings limit" (LEL) which is currently £64. Employees who earn less than the LEL do not pay any NI contributions, however once earnings exceed this threshold a kind of "entry fee" of 2% of the LEL has to be paid. In addition, a contribution of 10% of weekly income above the LEL, but not exceeding the "upper earnings limit" (UEL), which is currently £485,is payable to the fund.Therefore the minimum contribution to the NI fund is currently £1.28, that is 2% of the LEL. This would be paid by a person on a weekly wage of £64. The maximum weekly contribution is £43.38, that is, 2% of the LEL (£1.28p) and 10% of the difference between the UEL and the LEL (£42.10). This is paid by anyone earning over £485 per week. Employers' ContributionsEmployers also pay NI contributions for each of their employees who earns over the LEL.. Unlike employee contributions there is no maximum limit so contributions increase even when wages exceed the UEL.Contracting OutPayment of NI contributions entitles the employee to numerous benefits. One such benefit is the state earnings related pension scheme (SERPS) which is an earnings related addition to the basic retirement pension. However, if an employer has an eligible pension scheme then their employees can be contracted out of the state system into the employer's scheme. Such contracting out means that the employee is no longer entitled to receive a SERPS pension on retirement and their NI contributions are reduced accordingly. The reduction in NI contributions occurs to the percentage levied on the earnings between the LEL and the UEL which falls from 10% to 8.4%. The secondary contributions by the employer for a contracted out employee are also 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 to be directed into an approved personal pension fund. In this case the employee and the employer still pay the normal NI contributions applying to those not contracted out, but at the year end a rebate is paid by the Exchequer into the employee's personal pension fund. The rebate is the difference between the NI contributions actually paid by both the employer and the employee and the amount they would have paid had the employee been contracted out into an employer's pension scheme. Also if the employee is over 30 years old, a "sweetener" of 1% of earnings above the LEL and below the UEL is added to the rebate. Value Added TaxThe IFS estimates that value added tax (VAT) will raise £53 billion in 1998-99. The standard rate of VAT is currently 17.5%. However, VAT is charged 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 the costs 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 the sum of the prices they paid for materials and other inputs, and the price they charge for the final good or service. Zero-Rated GoodsApproximately 25% of consumer spending is on zero-rated goods. Zero-rated goods are treated in the same way as standard-rate goods, except that a 0% rate of VAT is paid by firms on their inputs and charged on their final goods. Currently the most important zero-rated goods are:
VAT-exempt GoodsAbout 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 charged on the final good sold to the consumer. The effect of this is that a lower tax rate is levied on these goods. The main VAT-exempt goods are:
Excise DutiesThe 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 of a 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. Vehicle Excise DutyVehicle 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. VED for cars is currently £150 per year.State BenefitsState Benefits in Britain today can be divided into three broad categories: Means-Tested BenefitsThere are three benefits which are given solely to families on low incomes, and which are withdrawn as income rises. All depend on a comparison of the needs of a family with it's income. All have similar rules for the calculation of needs and for what counts as income. The three means-tested benefits are:
National Insurance BenefitsThese benefits are paid from the National Insurance Fund, and payable only to 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:
Other BenefitsThe most important of these is Child Benefit. which is paid to all families with children. Child Benefit is worth £11.45 per week for the first child and £9.30 per week for each subsequent child. Some lone parents receive a further £5.65p per week. These benefits will cost around £7 billion this year. Government SpendingGo to the policy tools section for more on this. Intro | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13 | 14 |
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