The proof Reeves will be unable to squeeze the rich
Rachel Reeves’s tax raids are already unravelling. The Chancellor has been warned that her war on wealth will backfire as tax-raising ambitions meet fiscal reality.
Ahead of the election, Labour claimed a raid on non-doms and private equity will help to pay for more NHS appointments.
Sir Keir Starmer also insisted the “broadest shoulders” will bear the heaviest burden in what he has described as a “painful” Budget on Oct 30.
The problem is that these shoulders already bear a significant load, and Treasury officials, who have become increasingly concerned that Labour’s raids will raise little money, are starting to realise that they have options.
New figures show that high-earning Britons are already paying more tax on their income for every extra £1 they earn than anywhere else in the G7.
Workers in the UK earning a salary of £120,000 a year, or roughly 2.5 times the average [mean] wage, have roughly 66p clawed back in taxes for every extra £1 they earn, according to data compiled by the OECD.
This “marginal tax wedge” of 66pc is higher than France’s rate of 60pc for someone earning 2.5 times the average wage, as well as in the US, where the marginal tax wedge is 33pc.
Marginal rates are crucial for work incentives because high rates discourage people from taking on extra hours or even a promotion.
The UK’s marginal wedge is particularly high because people who earn £120,000 also see their £1 of their tax-free allowance of £12,570 clawed back for every £2 they earn more than £100,000.
Officials at Britain’s tax and spending watchdog have already warned that high marginal rates are “bad for growth”.
David Miles, an executive at the Office for Budget Responsibility (OBR), warned last year that people clearly notice when more of their income starts being clawed back. “The amount of money they get to keep out of the extra hours they might work in a week clearly goes down—and it goes down quite a lot if you go from 20pc to 40pc. That is a meaningful change. That has, in itself, a negative effect.”
But it is also worth stressing just how reliant the UK has become on higher earners to fund vital public services such as hospitals and schools.
Income tax is the single biggest revenue raiser in the UK, generating more than £300bn for the Exchequer every year.
Official data show the top 1pc of earners – who have incomes exceeding £214,000 – are expected to account for 28.2pc of all income tax revenues this year.
By contrast, the bottom 50pc will contribute 9.5pc of revenues, according to HM Revenue & Customs (HMRC).
The burden on top earners has grown both under Labour and the Tories.
Back in 1979, the top 1pc of earners paid 11pc of all income tax. By 2000, this had grown to 22pc.
Meanwhile, the bottom half have actually seen their tax share almost halve from 18pc in 1979, with steady increases in the tax-free personal allowance taking millions out of tax altogether.
Carl Emmerson, deputy director of the Institute for Fiscal Studies (IFS), highlights that many above-average earners have actually seen their “direct tax bills cut a lot” over the past few decades.
“Under Conservative chancellors since 2010, it is the very, very top that’s been hit pretty hard,” he says.
“They didn’t shout about that, and Labour don’t shout about it either, but there have been increasing efforts to get more money from the top.
“You do have to be careful, because when you’re already getting a lot of money from them, and you’re trying to get a little bit more, if these people start changing their behaviour, it means you can end up losing revenue. That’s the problem.”
It’s not just the very top who are paying more, but an increasing number of middle-class families.
HMRC data also shows more than 1.1m people in the UK who earn above £125,140 and pay the 45p top rate of tax are responsible for a staggering 41pc of all income tax revenues.
That’s £124bn in total from just 2pc of the population, or an average £110,000 each this year.
These people are not just bankers and lawyers, but headteachers, NHS consultants and top civil servants.
A six-year freeze in income tax bands will push even more of the tax burden on to these higher earners, with 600,000 more of them dragged into the 45p band by the end of the decade.
The OBR predicts 2.7m people will start paying the 40p rate by 2028-29 because of “fiscal drag”, which pushes more people into higher income tax brackets as pay rises but thresholds remain stagnant.
The crucial thing is that many of these people also pay capital gains tax (CGT), which is one of Ms Reeves’s top targets in her maiden Budget on Oct 30. The tax, which is levied on the profit of an asset when it is sold, is paid by just 350,000 people every year, but generates £15bn in revenues mainly from people at the top of the income distribution.
HMRC data shows that in 2022-23, people with gains under £50,000 and taxable income below £37,700 contributed 5pc of the total gains and represented 38pc of those liable to pay CGT.
By contrast, 44pc of gains for individuals came from just 11pc of CGT-liable individuals with taxable incomes above £150,000. “Higher and additional rate taxpayers tend to realise greater gains than those with lower taxable incomes,” HMRC says in its latest analysis.
Lord Johnson of Lainston, former investment minister, says Labour is in danger of turning off the very voters it was able to woo in the last election.
“There’s an assumption that higher rate taxpayers are ‘rich people’, but actually the rate that it kicks in would hit a secondary school teacher for example who probably doesn’t consider themselves to be rich or certainly who Labour is targeting,” he says.
“But these people are going to fall ever deeper into the net of the desire for the Government to try and tax as much as possible.”
He warns that hitting capital gains will only backfire. “If you derogate the principle of return from risk, then you are going to get less people taking it, and you’re going to get less investment, fewer inventions and less growth.
“So it’s completely mad to distort a tax system that’s worked well purely for dogmatic reasons, because it doesn’t actually end up raising more tax.”
All this suggests that Reeves may not be able to pump a meaningful amount of money into public services without breaking her manifesto pledge to not tax “working people”.
Dan Neidle, a tax lawyer, noted on a recent IFS podcast that the feat would be unprecedented. “Every single developed country in the world that spends more on public services than the UK, raises that money through higher taxes on average earners than the UK, without exception.”
Tory advisers, meanwhile, are enjoying life on the outside. “We’ve all been laughing at how we imagine all our replacements are telling Treasury officials that the Resolution Foundation and IFS say this tax policy raises billions,” says one. “Only for them to come back and say: ‘Well, no. It doesn’t. Sorry. But by the way, have you considered a rise in employers’ National Insurance or VAT?’”