Tax squeeze will hurt a year from now: Vivien Goldsmith looks at what the budget will cost taxpayers

THE Chancellor's Budget was indeed taxation by stealth, as we predicted last week. But the taxation squeeze is set to accelerate one year hence, when the real impact of the gradual move towards making 20 per cent the standard tax rate will be felt.

The widening of the 20 per cent band by pounds 500 in 1993/94 to the first pounds 2,500 of taxable income brings a windfall of just pounds 25 to taxpayers whose income exceeds this limit. This will be in the first pay packet for employees after 17 May.

The 20 per cent band is due to rise by a further pounds 500 in the following tax year. But it will need to be raised much further to counteract the effect for many taxpayers of withdrawing tax reliefs at marginal rates.

The married couples' allowance and mortgage interest tax relief will be cut back to 20 per cent in April 1994. So far, pension contributions retain tax relief at the payer's top rate.

So although other tax changes have dented the attraction of tax-free savings in equities (pensions and personal equity plans will, in effect, suffer a reduction of 6.25 per cent in their dividend income), higher rate tax payers should consider taking advantage of pensions tax relief as it looks increasingly out of place.

National Insurance contributions - taxation by another name - are also set to rise a year from now. Without any change in the bands this could make self-employed taxpayers about pounds 150 a year worse off, and employees up to pounds 190 worse off.

Taxpayers have also missed the usual indexing of rate bands. This would have added pounds 90 to the basic 25 per cent band and pounds 50 to the married couples' allowance for the under-65s.

The married couples' allowance for the over-65s will be increased by pounds 200 in 1994/95 to mitigate the loss of tax relief. This will make those using all the 20 per cent band pounds 40 a year better off. Wealthy pensioners whose income takes them well into higher tax rates will be pounds 428 a year worse off. The break-even point comes at incomes of about pounds 10,000.

Mortgage interest tax relief has been withering away as inflation has reduced the significance of pounds 30,000. Tax relief has already been restricted to 25 per cent. The squeeze down to 20 per cent in 1994/95 will cost up to pounds 10 a month at current mortgage rates.

Married couples should not be be distracted by the Budget announcements of changes in the married couples' allowance coming in a year's time.

The deadline for organising the way the pounds 1,720 allowance is paid for the whole of 1993/94 is 5 April, when wives have a right to half of it. Couples can also agree between themselves for the wife to take the whole allowance.

Questions of fairness may outweigh the financial advantages to the couple. The pounds 1,720 allowance is worth pounds 688 to a 40 per cent taxpayer and pounds 430 to a basic 25 per cent taxpayer.

But from April 1994 the allowance will only attract relief at 20 per cent. With 20 per cent relief, the full allowance saves just pounds 344 tax.

It is still worth holding shares within a personal equity plan to shelter dividend income from tax, in spite of the Budget changes, acording to PEP managers.

They point out that higher rate taxpayers will have to pay more tax on their dividends when the tax credits given on net dividend payments are reduced from 25 to 20 per cent after 5 April. They may get a reduced boost to their PEP savings due to the change, but they will still be much better off than holding shares outside a PEP.

For basic 25 per cent taxpayers, the change will not affect shareholdings outside a PEP as the 20 per cent tax credit will be deemed to have wiped out their tax liability.

Investors who are buying unit trusts might as well have their holdings within a PEP, as many managers make no extra charge for setting up a PEP. Roger Jenning, marketing manager at M&G, said: 'Gilts don't suffer from the same change, which makes them slightly more attractive, but in the long run you are much better off having your money in productive assets.'