More Break Even Point Fun

Calculating the total income tax and National Insurance deductions for various salary levels is a tortuous procedure, as there are various different thresholds for income tax (the personal allowance and the higher rate tax threshold) and for National Insurace (Lower and Upper Earnings Limits for Employee's NIC and the Primary Threshold for Employer's NIC) as well as three different rates of income tax (0%, 20% and 40%), three different rates for Employee's NIC (0%, 11% and 1%) and two rates for Employer's NIC (0% and 12.8%), so it's far easier to easier to use the online PAYE calculator.

The fun part is that if you ignore extra complications (like Student Loan Repayments; the 50% super tip top tax rate; the exemption from Employee's NIC for people over pensionable age; the fact that the higher rate tax threshold is not quite aligned with the Upper Earnings Limit for Employee's NIC etc etc) and chuck it all in the pot you can boil it down to a simple formula: the total deductions for 2010-11 (including Employer's NIC) for somebody with a normal personal allowance are the higher of:

a) Annual salary minus £6,064 x 43.8%, or
b) Annual salary minus £13,090 x 53.8%.

Check it and see.

In other words, higher earning employees have a 10% higher tax rate, but a doubled personal allowance. We can up the ante a bit by treating Working Tax Credits (30 hour rate) as negative tax, and third calculation is:

c) Annual salary minus £9,505 x 82.8% (even if you end up with a negative result, see below).

The total tax burden is then the higher of (b) and [the lower of (a) and (c)].

The calculation for somebody on tax credits seems absolutely bizarre - they have a lower personal effective personal allowance than higher rate taxpayers and a higher tax rate! The reasons for this are:

i. If you work 30 hours, you are assumed to earn at least the National Minimum Wage of £5.80, so the tables start at an annual salary of £9,000 or so. The basic entitlement for somebody on the 30-hour WTC is £2,710, but this is tapered away at 39% once your annual salary exceeds £6,420.

ii. So it's Catch-22 stuff: to get the 30-hour element you have to be earning £9,000, but if you earn £9,000 they take away (£9,000 - £6,420) x 39% = £1,006 from the £2,710, so the most you can possibly get is (£2,710 - £1,006) = £1,704. Whoever thought this up was either a genius or a madman, and he was definitely a madman.

iii. The total tax burden is 82.8% of your headline salary, because you pay 20% income tax, 11% Employee's NIC + 12.8% Employer's NIC and 39% WTC withdrawal. This rate might, just might, be a little beyond the top of the Laffer Curve, eh?

iv. If you are earning £9,000, your employer is already paying £1,286 tax and NIC, so out of that lovely £2,710 30-hour WTC they promise you, they take £1,006 from you and another £1,286 via the PAYE system and you end up with net £418 added to your gross income. This tallies with the result from (c). £9,000 minus £9,505 = negative £505 x 82.8% = £418.

Think about that the next time that a [Labour] politician says that "Working Tax Credits make work pay." The most you can get is £418 a year, or £8 a day a week, barely enough to cover your bus fare.

Why any politicians doubt that having a single, higher personal allowance (the higher the better) and a flat rate of income tax (the lower the better) is a better way of doing things - even for people currently on Working Tax Credits - is a mystery to me. OK, they are stupid, they like gimmicks, they think they know better, they have officious civil servants lying to them to protect their departmental budgets and so on, but does none of them have any grasp of maths?