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John Andrews of the Low Incomes Tax Reform Group highlights some issues and anomalies resulting from the abolition of the 10% starting rate of income tax, and the introduction of a 'new' 10% rate for savings income.

The strange workings of the new 10% rate

The abolition of the 10% starting rate band was intended to simplify the tax system.

But does that claim really bear close scrutiny?

When Gordon Brown announced the reduction of the basic rate from 22% to 20%, he also abolished the 10% starting rate – but not completely. He kept a 10% rate for savings income that is within £2,320 of an individual’s personal allowances after earned income.

Distinguishing savings income from earnings can make things very complicated indeed to understand. Below we provide some simple examples of five people, all with an income of £10,000:

James

James is 62, has a pension of £9,500 and savings income of £500.

Hugo

Hugo is 25 and does not work, but has inherited wealth of £200,000 which provides him with £10,000 of savings income.

Glenda

Glenda is 60, she has a State Pension of £2,500 and she has purchased an annuity (regarded as savings income) which produces for her a taxable income of £7,500.

Denise

Denise is 45 and married. She works 10 hours a week for £7,500 a year. She has deposit interest of £2,500.

Charlie

Charlie is 30 and single. He works 25 hours a week for a wage of £10,000.

Their tax liabilities are as follows:

Tax due

James £913

Hugo £681

Glenda £681

Denise £887

Charlie £913

LITRG deals with people on low incomes, although not generally people as well placed as Hugo. However, we think it might be difficult to explain to these diverse individuals just why their tax liabilities are so different.

People like James will certainly wonder why his position is worse than that of Hugo when he has fewer savings. Charlie might also have a view as to why savings are regarded more highly than labour.

The processes that these people will have when interfacing with HMRC will be varied. James and Charlie will be in PAYE; Hugo will be in Self-assessment; and Denise and Glenda will have to make a repayment claim. We will return to the practicalities of people actually getting the right amount of tax paid in our next instalment on this subject.

Finally, the method of calculation is complex, as we illustrate in other parts of our website (http://www.litrg.org.uk/help/pensioners/taxbasics/working.cfm).

Might there be simpler ways of achieving the same ends? We are giving it some thought.

Widows, single pensioners and the 10% tax charge

The abolition of the 10% tax band will increase the tax liability for some people under 65 who are not entitled to tax credits. Women pensioners between the ages of 60 and 64 on low incomes are hit particularly badly by the abolition of the 10% band of tax from 6th April 2008.

This is not just because of the increase in tax, but also because of the lack of joined-up systems between HM Revenue & Customs (HMRC) and the Pension Service.

The debate about the fairness or otherwise of the abolition of the 10% tax band rumbles on, but there has been no debate about whether the Pension Credit, which is intended to help pensioners on the lowest incomes, will compensate for the increase in tax bills.

Sending money round in a circle

Single women pensioners who get their pensions at age 60 are entitled to Pension Credit if their pensions do not exceed £6,450 in 2008/09 (assuming they do not have other income or savings over £6,000). Their personal allowance for 2008/09 is only £5,435 and they do not receive the higher age-related allowance available to people of 65 and over.

With the increase in their tax liabilities for 2008/09 (paying tax at 20% instead of 10%) they need that help more than ever.

But here is the rub. HMRC and the Pension Service between them make receiving this help almost impossible and many thousands will lose out.

Impossible processes

Firstly, HMRC insist upon putting the low income pensioner whose only source of income is a State pension (paid by another government department) into the complex Self Assessment system.

Secondly, the Pension Service do not tell such pensioners that the tax they pay on their State pension should be deducted when working out their entitlement to Pension Credit.

There is no joining up between HMRC and the Pension Service to see that those who are entitled to Pension Credit get that entitlement.

The result will be that the extra tax liabilities levied by HMRC will not get reimbursed by the Pension Service as they should be.

The example of Elizabeth

Elizabeth is 62. Her only income is her State pension of £6,500 for 2008/09. She did not receive Pension Credit in 2007/08 because she used the Pension Service online calculator and that told her that she was not entitled. This is because the calculator does not alert her to the fact that it is the income from her State pension net of tax that she needs to input. Neither does it highlight the fact that if tax is paid at a later date she may be able to get her Pension Credit reassessed.

Elizabeth’s tax liability has risen sharply to £213 in 2008/09 (£1,065 at 20%). Elizabeth is entitled to Pension Credit for 2008/09 of £164 but nobody in HMRC or the Pension Service will tell her. How is she expected to know?

Complexity and waste

John Andrews, Chairman of LITRG comments:

“The complexity is appalling for vulnerable people and means that many will lose the full protection against poverty that Pension Credit is supposed to provide. The failure of the Pension Service and HMRC to exchange information or explain things to the citizen is a failure of joined-up government and causes people to lose out on their entitlements.”

“LITRG is calling for people to have the option to have their State pension taxed under PAYE and meanwhile for HMRC and the Pension Service to be proactive in ensuring that people like Elizabeth receive what they are due.”