Julian Knight: Life's about to become a fiscal drag for the 40 per centers

 

Thankfully, there wasn't a pasty or caravan tax in sight in last week's Autumn Statement. Instead, what we had was a tale of pretty unremitting misery, particularly if you are in danger of breaching the 40p income tax band.

For you, the next five years will be a real drag – quite literally – as you find more of your income subject to 40 per cent tax. Add to this the confused child benefit changes which come into force in a matter of weeks and you can clearly see that Ed Miliband's "squeezed middle" are at the epicentre of this austerity.

Of course it could and probably will get much worse – over in Ireland they are preparing for their sixth austerity budget having already suffered swingeing pay and benefit cuts. Before this has finally played out I'd hazard a guess that we will be talking the same here, particularly if tax receipts continue to underperform – more on that below.

For a generation or more politicians have run scared of raising the rates of income tax. Instead, chancellors raise VAT and employ fiscal drag. But I'd argue that fiscal drag is infinitely more damaging to the economy than a simple rise in income tax. It stops people from taking overtime and the self-employed from taking on projects. Logically, are you going to go the extra mile if you can see half your extra income being taken in tax and national insurance? Place more people into the 40p tax band and you destroy a key driver of the economy, more so than if you raised income tax by 1p.

Up to 400,000 people are predicted to be subject to fiscal drag as a result of the Autumn Statement. So what to do if you are one of them? Well you have to use the few scraps that have fallen from the Chancellor's table. The individual savings account limit will rise by 2.1 per cent to £11,520 in April – this is a below-inflation rise but worthwhile nevertheless. And although annual pensions allowances and the lifetime limits have been cut, take advantage of the ability to save in a pension from your pre-tax salary.

Put as much as you can afford in because if government finances deteriorate – which is possible – you may find there are cuts to pensions tax relief in future budgets.

Scapegoats

When describing the likes of Google, Starbucks and Amazon's tax affairs, most Britons would probably like to paraphrase the old wartime saying about American GIs – there are three things wrong with them: they're overpaid, under taxed and over here.

But in reality these firms are a bit of a scapegoat for much wider, fundamental failings in our tax system. The real problems are much deeper. The UK tax system is drowning. Nearly a decade ago I wrote a book on tax – the official tax manual I needed to write it was about 500 pages long, but if I was to attempt to rewrite the book today the manual I'd need would come in at more than 1,100 pages.

Politicians of all hues find it too easy to simply add another law to chase the next headline that they are getting tough without addressing the real issue, which is how to create a tax system which gets the highest number of people paying the right amount of tax.

Of course, tax authorities are trying to catch fog. In essence, money follows ideas and is no respecter of national boundaries, this means much of the governmental tax base is being eroded away. This will fundamentally change the way governments can operate – they will be much smaller for starts.

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