I was asked to help a friend of mine, a (~50 year old) widow, complete her UK tax return recently. In the UK the final deadline for filling in your own tax return is 31 January, and the process these days can all be done online via the taxman’s excellent website. Her finances were illuminating.
What is a rich widow?
This widow’s income is roughly as follows:
- £45k of earnings. She is a freelance creative.
- £25k of investment income, about half of which was taxable (‘unsheltered’). She has about £700k of investments, roughly half in tax-free accounts (ISAs/SIPPs), and half unsheltered. She has no other income-generating assets.
- £10k of contribution to her pension. She is a (non-executive) company director of her ex-husband’s company which doesn’t pay her but does make £10k per year payment into her SIPP.
- £12k of (realised) capital gains last year, all in unsheltered accounts .
This lady’s total income/gains last tax year amounted to over £90k. This puts her in the top 10% of the UK by income, but not the top 5%.
But how much does an ‘average striver’ pay in tax?
Now, before we continue with my widow friend, let’s have a think about ‘average Joanna’, a typical striver in the UK.
Consider Joanna, a (hypothetical) 50 year old who works full-time for the NHS, earning £45k (roughly the London average wage). For a like-for-like comparison, her pension (contribution, from her employer) and (NHS pension investment equivalent) income on top of this would add about £25k to her taxable income, all tax-free.
Joanna pays £6.6k of tax, and £4.4k of national insurance, totalling £11k of tax/NI. This works out as 24% of total gross pay.
How much tax does this ‘rich widow’ making £90k pay?
What total tax/social charges (National Insurance, in the UK) do you think she owes on her annual income/gains?
Before continuing reading, think of a number.
My friend is clearly ‘well off’. Rich, you might argue. Her income last year was comfortably ahead of an MP’s salary (though not an MP’s total earnings, on the same definitions). With over £80k of income you’d think she was clearly a higher rate income tax payer, and so some of her income would be taxed at 40%+. If you estimated that she pays about 30% tax then you’d have been where I would have guessed, given a few seconds to think about it.
If you guessed about 20%, on the basis that I wouldn’t be writing a blog post about this if it was an easy number to guess, then fair cop to you.
The actual figure? This well off widow’s tax bill (including her Ltd company’s tax bill) for the last tax year totals….. less than £10,000.
In other words, around 17% of her pay, and only 10% of her total income/gains. I think, based on the figures in this BBC article, that on a personal basis the widow is in the bottom 5% of UK income tax payers.
One of two big drivers of my friend’s low tax rate is that she works through her own Ltd company, and all her £45k turnover goes through it. This Ltd company employs her, on a salary of £11.5k (co-incidentally the personal allowance, i.e. the amount you are allowed to earn personally before paying any income tax). The company then declares a profit of over £30k, pays 19% corporation tax on it, pays about £400 national insurance (on the £11.5k salary), and passes the rest through to her as a dividend (on which she pays a further 7.5% tax).
The other big help for my friend is the tax assistance she is getting for her pension and ISA saving. The £10k pension contribution she receives is tax completely free. And the £10k-£15k dividends that her pension/ISA investments receive is also tax free. In this respect, my friend is taxed very similarly to ‘average Joanna’; in fact because she has, relatively, a smaller pension but more assets outside the tax-free pot, she is arguably more highly taxed than Joanna.
The rich are just like you and me, but pay less tax?
There is something counter-intuitive about the UK’s tax system.
- A young graduate in a good job, earning perhaps £35k, will pay tax/NI of around 25% of earnings, but will see deductions of over 33% of earnings (due to their income-contingent student loan repayments a.k.a. graduate tax).
- That young graduate’s dad, in a similar job, who by now is significantly richer than the young graduate, will probably be paying tax/NI and deductions of under 25% of earnings due to having more pension/similar assets saved, and no loan repayments to make.
- And some richer folk out there are paying tax/deductions of under 20%, as per my widow friend. On average, the top 10% of households by income (equivalent to income of £75k+, I estimate), are paying an average tax rate of ‘only’ c.30% of total income, based on my reading of the UK Treasury’s 2017 graph below (which does need careful attention!).
There is something odd that the highest tax rates apply to regular jobs, and lower tax rates apply to unearned income, and then arguably the lowest of all tax rates apply to fixed property. You’d think the government didn’t like people to work in jobs.
When the left says ‘let’s tax the rich more’, the media immediately jumps to ‘that means putting up income tax, and then normal middle class people will be paying more than 50% of their income as tax’. Not likely, that isn’t.
I can’t help but wonder about the policy implications from these observations.
While no firebrand leftie myself, it feels reasonable to me to ask richer people to pay more tax than poorer people. Obviously there will be reliefs/incentives that will create exceptions/opportunities but the widow I’m describing here doesn’t deploy very many of those.
Putting it another way, I think people like my widow friend could pay, say, £12k of tax instead of £10k of tax (i.e. 20% more tax) and it wouldn’t cramp her style at all. If you could increase the tax take from the top 1% of the country by 20% you’d have, well, enough to paint a lot of red buses.
For starters, she should pay more National Insurance than the £400 she pays at the moment. By contrast, Joanna pays over £4k NI. This was the direction Phillip Hammond, our Chancellor, went in until he got stopped by the Tory backbenchers / media backlash / cowardly PM / take your pick. If you made the minimum contribution £1500 you’d have an extra £1k out of her straight away.
Secondly, the increase in personal allowance, much as it is positioned as ‘lifting poorer people out of the tax net’, the main beneficiaries are the higher earners like the widow. If her allowance was £6k, not £11k, you’d have another £1k out of her. Job done.
Of course you could tax unearned income more. Dividends and/or capital gains could be taxed more. To make £1k more out of my widow you’d need to reduce the dividend allowance to nil, or put her dividend tax rate up to 15%, or a blend of both. I think these would have ‘unintended consequences’ because money is easy to move. Certainly it would be good for accountants and lawyers.
You could raise corporation taxes. If you put an extra 3% on corporation tax, raising it to 22%, you’d have over £1k more from my friend. The 26% proposed by Labour would raise over £2k more from her; annoying, but I contend it would change very little. But some companies would leave the UK, and others might not move here; I suspect Labour would end up with a lot less than the £2k they think they’ll get.
You could raise property taxes. My friend hasn’t moved for ages, won’t move if she can help it, but lives in a house worth over £2m. Her council tax of around £2000 amounts to 0.1% of her property value a year – a fraction of what she’d pay in the USA, for instance. If you asked her to pay a ‘mansion tax’ of 1% p.a. she’d feel you were forcing her out of her home, but if she was asked to pay £4000 a year council tax, she could definitely do it. She would however hiss and cluck a lot.
Or, you could put income tax rates, any of them, up to whatever you like. It wouldn’t raise a penny from my friend the widow.
Either way, those blasted taxes don’t seem too bad from this perspective. At least as long as you don’t go to university just in order to ‘get a proper job’. What am I missing?