Income Tax Personal Allowances
The 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 £4,535 (this is the pre-announced
value from April of 2001). For example, iftotal income is £10,000
then taxable income is £5,465 (£10,000- £4,535).
Persons aged 65 to 74 receive a higher personal allowance of £5,990,
while those aged over 75 are entitled to an allowance of £6,260However,
if income exceeds a certain limit known as the "income limit forage related
allowances" (£17,600) then the over 65 allowancesare reduced.
Income Tax Rates
Different tax rates are applied to taxable income depending upon the "tax
band" that income falls within. From April 2001, the first £1,580
of taxable incomeis taxed at the "lower rate" of taxation which is presently
20%, the next£27,820 is calculated at 23%, the "basic rate". All taxable
incomeabove this ceiling which is known as the "basic rate limit" ie, over
£29,400,is taxed at the higher rate of 40%. The rate at which any
extra earnedincome is taxed is known as the "marginal rate" of taxation.
|Tax Rates and Bands
|Taxable income per year
|Rate of tax(%)
|0 - 1,580 (Lower rate band)
|1581- 29,400 (Basic rate band)
|Over 29,400 (Higher rate band)
In the budget, the Chancellor normally increases the tax allowances andbands
to allow for inflation.
Examples of Income Tax Calculations
The following examples show how bills are determined under the currentincome
- A person earning £3,000 per year.
The personal allowance is £4,535 so no income tax is paid.
- A single person on an income of £15,000 per year .
The personal allowance is £4,535 so taxable income is £10,465.
The lower rate of income tax, 10%, is paid on the first £1,580
(£158) and 22% on the remaining £8,885 (£1,954.70p)
giving a totalincome tax bill of £2,1127 (£158 +
- A married person with an income of £42,150 per year.
Taxableincome is £37,615 (£42,150 less the personal allowance
of £4,535),of which £1,580 is taxed at 10% (£158)
and the next £27,820 at 22% (£6120.40p). The remaining £8,215
is taxed at the higherrate of 40% (£3,286).
Payment of National Insurance (NI) contributions entitles individuals toreceipt
of certain social security benefits, of which the state retirementpension
is the most important. Although payment confers entitlement, NIcontributions
paid by today's workers actually pay the benefits of today'sunemployed,
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 sameway as a private pension
or insurance fund. In the NI system current contributionsfinance current
benefit payments with the fund merely being a device toprevent cash flow
The fund officially should not fall below one sixth of NI expenditure
for that year. Historically this has been achieved through a grant fromcentral
taxation, because contributions paid into the fund were not enoughto meet
benefits paid out. The high level of economic activity in the mid-1980swhich
expanded contribution levels allowed the grant to be abolished in1990.
However the recession which followed reduced contributions and substantiallyraised
the costs of benefits so that the grant had to be re-introducedfor 1993-94.
For the year 2000/1, NI contributions are expected to raise about £60billion.
About 95% of the income raised is from Class 1 contributions whichare
paid by two groups, employees as a tax on their earnings, and by employersas
secondary contributions on those they employ. Since 1975 NI contributions
from both employers and employees have been earnings related subject toan
earnings floor, with a maximum premium for employees. The remaining5%
of income raised comes mainly from the self-employed (Class 2 and Class4
contributions), with voluntary contributions (Class 3) making up about0.1%
of the total.
Our model allows changes to employees NI only.
Employees pay a NI contribution if their weekly earnings exceed the "lower
earnings limit" (LEL) which is currently £87. The rate is 10% for
those in the State Earnings-Related Pension Scheme. The Upper Earnings limit
is currently £575 p.w., above which no extra contributions are made.
Employers also pay NI contributions for each of their employees who earns
over the LEL.. Unlike employee contributions there is no maximum limitso
contributions increase even when wages exceed the UEL.
Payment of NI contributions entitles the employee to numerous benefits.One
such benefit is the state earnings related pension scheme (SERPS) whichis
an earnings related addition to the basic retirement pension. However,if
an employer has an eligible pension scheme then their employees canbe contracted
out of the state system into the employer's scheme. Suchcontracting out
means that the employee is no longer entitled to receivea SERPS pension
on retirement and their NI contributions are reduced accordingly.The reduction
in NI contributions occurs to the percentage levied on theearnings between
the LEL and the UEL which falls from 10% to 8.4%. Thesecondary contributions
by the employer for a contracted out employee arealso 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 tobe
directed into an approved personal pension fund. In this case the employee
and the employer still pay the normal NI contributions applying to thosenot
contracted out, but at the year end a rebate is paid by the Exchequerinto
the employee's personal pension fund. The rebate is the differencebetween
the NI contributions actually paid by both the employer and theemployee
and the amount they would have paid had the employee been contractedout
into an employer's pension scheme. Also if the employee is over 30years
old, a "sweetener" of 1% of earnings above the LEL and below theUEL is
added to the rebate.
Value Added Tax
The IFS estimates that value added tax (VAT) will raise £59 billion
in 1998-99. The standard rate of VAT is currently 17.5%. However, VAT ischarged
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 thecosts
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 thesum
of the prices they paid for materials and other inputs, and the pricethey
charge for the final good or service.
Approximately 25% of consumer spending is on zero-rated goods. Zero-rated
goods are treated in the same way as standard-rate goods, except that a0%
rate of VAT is paid by firms on their inputs and charged on their finalgoods.
Currently the most important zero-rated goods are:
- Most food (not alcohol, soft drinks, confectionery and crisps and
- Construction of new dwellings
- Passenger transport
- Books, newspapers and magazines
- Medicines on prescription
- Children's clothing
About 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 chargedon
the final good sold to the consumer. The effect of this is that a lowertax
rate is levied on these goods. The main VAT-exempt goods are:
It should be noted that VAT is not levied on any exports but is chargedon
- Private education
- Health Services
- Postal services
- Finance and insurance
- Burial and cremation
The 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 ofa
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 Duty
Vehicle 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.
Until June 1999, VED was levied at a fixed rate per vehicle, but the structure
was changed in the 1999 Budget to include a lower rate for small cars. In
the March 2000 Budget, further changes to the system were announced, which
will come into effect from March 2001. First, the small-car threshold was
increased from 1,100cc to 1,200cc and, second, a new system of graduated
VED for new cars was introduced. This involves placing cars in bands according
to their rate of carbon dioxide emissions and charging VED accordingly.
This system will apply only to new cars because detailed information about
carbon dioxide emission performance is only available for new cars.
State Benefits in Britain today can be divided into three broad categories:
There are three benefits which are given solely to families on low incomes,and
which are withdrawn as income rises. All depend on a comparison ofthe
needs of a family with it's income. All have similar rules for thecalculation
of needs and for what counts as income. The three means-testedbenefits
- Income Support (non-contributory Jobseekers Allowancefor
This is in effect the state "safety net" benefit. To qualify you
mustnot be in full time work (16 hours per week or over). For those
who qualify,income is brought up to the level of needs (known as their
"applicable amount"). The applicable amount is calculated by adding
together personal allowances (basic amounts for each person,
chiefly dependent age) and permia (extra amounts for those
in special circumstances, such assingle parents or the disabled).
The applicable amount for a single personover 25 will be £53.05p
per week from April, whilst for a single parentwith two children aged
under 11 it would be 94.85 per week. All income above a small disregard
is withdrawn £ for £.
Those in receipt of Income Support generally qualify for 100% housingbenefit
rent and council tax rebates, and some will have their Mortgage Interest
payments met. About £18,000 million will be spent on income
support this year.
- Working Families Tax Credit (WFTC)
This is a benefit for low income families in full time work (more
than16 hours per week). A maximum Family Credit is calculated in much
the sameway as under Income Support (but with different values: £106p
for ourSingle Parent above). Income is then compared to a threshold
(£92.90 from April). If income is less than this, maximum family
credit is paid.For incomes greater than this, benefit is withdrawn
at a rate of 55p inthe £. For example, if our single parent
worked 20 hours per week andearned £100, then she would receive
102.10 in WFTC (£106 maximum less 55% of (£100
- Housing Benefit
This reduces the rent and council tax of all those on low incomes.
Both employed and unemployed are eligible. Needs and Income are calculated
in the much the same way as for Income Support. Those with income
belowneeds will in most cases have all their rent and council tax
paid (rebated).Those with incomes above needs have their rebates reduced
at the rate of65p in the £ for rents and 20p in the £
for Council Tax.
National Insurance Benefits
These benefits are paid from the National Insurance Fund, and payable
onlyto 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:
- Retirement Pension is worth £72.50 per week to a single
pensioner and £104.25 per week to a couple There are deductions
for those who haven't paid enough National Insurance contributions,
andadditions for those who have paid in to the State Earnings Related
PensionScheme (SERPS). About £36 billion willbe
paid in state pensions this year.
- Contributory Job seeker's allowance replaced Unemployment Benefitin
- Incapacity Benefit which replaced Invalidity Benefit in 1995;
Formost claimants this is worth £69.75 per week.
The most important of these is Child Benefit. which is paid to
allfamilies with children. Child Benefit is worth £15.50 per week
forthe first child and £5.15 per week for each subsequent child.
Government expenditure in the UK for 1999/2000 is expected to be £349bn.
A lot of money! Seen like this, the importance of government expenditure
to the economy is very clear. The government pays for defence, education,
social security, health, roads, museums, libraries, the police and courts
and.............. All these are vital public services and any changes
in the government's spending policies will have a major impact on the
Adjusting the level of government expenditure is a key part of the government's
It is possible to change the level of government expenditure in the model
and see the effect both on the macroeconomic targets and on individual