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Spend & Save

Julian Knight: Joining the 40 per cent club? What a drag

I'm not sure if the new tax year, which starts on Wednesday, represents the end of the beginning or the beginning of the end. After three years of mostly fiscal expansion in a bid to pump-prime the UK economy, this week marks the end of the expensive financial experiment as the tax calendar flips over from 2010-11 to 2011-12.

Normally, the change in a tax year brings some minor tinkering, but this time it seems a real red-letter day for coalition politics and the austerity to come.

Wednesday is probably a red-letter day for many of you too – not because it represents the chance to make use of a fresh ISA allowance, or the end to employers forcing you out of the door at 65 if you don't want to stop working (see page 97) – but because a fair percentage of you will start to find yourselves, suddenly, higher-rate taxpayers.

Fiscal drag à la carte is on the menu from 6 April. Let me explain. In 2010-11, people under 65 could earn £43,875 before they were taxed at 40 per cent, but in 2011-12 this figure drops to £42,475. That's a £1,400 cut – instantly pushing 750,000 people into a higher tax bracket.

Undoubtedly, over the next couple of years, the number of ordinary people who will be paying 40 per cent will increase enormously – middle-ranking teachers and police, senior nurses, performance-target hitting sales reps, some supervisors in call centres and retail middle managers will all be joining the unhappy 40 per cent club.

What's worse, is that when you see that money disappear from your paypacket you can bet that the very rich – despite the 50 per cent tax band – will probably be paying a lot smaller percentage of their salary because they can afford the accountants and wealth mangers who can help them, perfectly legally, to shelter their money from tax. Never has the tax system been so unfair to what Ed Miliband calls the "squeezed middle" – and the Labour leader, as a Gordon Brown acolyte, remember, has had at least one hand on the pliers doing the squeezing.

Taxing so many more people at 40 per cent can be largely self defeating, too. Think of it this way, if you're one of those shunted into the 40 per cent bracket and you have the opportunity to take on a little extra work, do a little overtime – where is the motivation when half of what you earn instantly disappears in tax and National Insurance? Fiscal drag soon leads to economic drag, and that's without mentioning the damaging effect of taking hundreds of pounds out of people's pockets in 40 per cent tax.

And if you thought the tales of the damage wrought by the cuts was becoming repetitive in the extreme; you haven't seen anything yet. The government spending cuts are about to go into overdrive. So, the end of the beginning? Yes, because the party which began in the mid-1990s finally ends on Wednesday. It's been a rag-tag affair for several years, a false economy of incredibly low interest rates and inefficient government spending that has been the equivalent of the stale punch sitting in the corner.

As for 6 April as the beginning of the end? Well, the date hardly has the same apocalyptic milieu as 2012 in the Mayan calendar, but whether or not it gets radically worse from here depends on so many factors: Will the coalition cuts genuinely work? Are they enough? Will the eurozone hold together? Will the Irish banks and government finances completely collapse? (Our exposure there is huge.) Will the economy slip back into recession? Can inflation be halted? Will the Government's tax take fall, sparking a crisis in the markets leading to much higher interest rates and further recession? Your guess is as good as mine as to whether all, some or none of this comes to pass. Nevertheless, 6 April starts a financial year when the answers to many of the questions above will become clear.