In remembering Lord Lawson, it is surely his 1988 Budget which will stand as his defining moment as chancellor. Indeed, it was one of the defining budgets of my lifetime.
It was the year in which he abolished all rates of income tax above 40pc: before 1988 there were rates of 40, 45, 50, 55, and 60pc for higher earners. At the same time, he cut the basic rate of income tax from 27pc to 25pc. He also announced independent taxation of husband and wife, sweeping away the 180-year old system which treated the income of a married woman as if it belonged to her husband. And he even found time to reform capital gains tax, bringing rates into line with income tax.
It turned out that the scale of the tax cuts was poorly judged from a macroeconomic point of view. They bore at least some responsibility for the boom and bust that followed. But Lawson’s reputation as a tax reformer is well deserved. He left the tax system in a far more coherent and much simpler state than that in which he found it. The same cannot be said for any of his successors. Most, if not all, have achieved the reverse.
Those reforms were a huge simplification, a big boost to incentives for higher earners and, of course, a big giveaway to the rich. They played their part in cementing higher levels of income inequality which had grown so fast during the 1980s – though they were by no means the main driver of those changes. That broad, simple structure of a dual rate income tax system largely survived for 20 years.
The vast majority paid at the basic rate, which was gradually reduced to 20pc under both Conservative and Labour chancellors, while a smallish minority paid the 40pc higher rate.That legacy has been almost entirely trashed since 2010.
The least of the changes has been the introduction of a new 45pc top rate of tax. Originally introduced in 2010 as a 50pc band on incomes over £150,000 by Alistair Darling, this additional rate was cut to 45pc by George Osborne in his 2012 Budget, amid concerns over its effectiveness in actually raising additional revenue. But the £150,000 limit was never increased, so numbers paying tax at 45pc grew inexorably. And then in Autumn 2022 Jeremy Hunt brought the threshold down to £125,140. That new threshold applies as of today.
There was a reason for choosing £125,140 as the new threshold. It’s because there is a rather less well known 60pc rate of income tax that applies on incomes between £100,000 and £125,140. Also introduced by Mr Darling, this 60pc band is, formally, a withdrawal of the income tax personal allowance. But call it what you will, it is an income tax rate of 60pc. (There is an additional 2pc National Insurance rate on earnings on top.) As with the point at which the 45pc rate becomes payable, the £100,000 point at which the 60pc rate begins has remained the same in cash terms for 13 years. Conservative chancellors may not have introduced these higher rates, but they have ensured that they affect growing numbers of people.
We are also now in the midst of a six-year freeze in the point at which the 40pc rate starts to bite. These long running cash freezes are having a transformative effect on our income tax system. Within a couple of years around 3pc of all adults (or nearly 5pc of income tax payers) will be paying income tax at either 60pc or 45pc – that’s more than 1.5 million people and about the same as the fraction of the population that was paying tax at 40pc back in 1990. Meanwhile the 40pc band, which used to be the preserve of the highest earners, is swiftly becoming the norm for the middle classes. By the time the freeze is over, about one in seven adults, and a fifth of income tax payers, will be subject to at least the 40pc tax rate.
All of that represents a decisive enough move away from the Lawsonian settlement, but there is more. For some of those on even higher incomes, above £260,000 a year, there is effectively a much higher rate of income tax because of the way in which the annual allowance for pension contributions is withdrawn. The recent budget may have got rid of the lifetime allowance, but it left us with a pernicious and hugely complex set of rules around annual contributions.
Further down the income distribution, among some of those earning close to the £100,000 mark, there is an even more dramatic problem. Entitlement to free childcare, an entitlement which was extended to the under threes last month, is ended once income hits £100,000. Childcare is expensive enough that it is perfectly possible for a parent with a couple of children to be better off earning £99,000 than earning £130,000.
Further down the income scale again, well over half a million parents with incomes between £50,000 and £60,000 face marginal tax rates of 55pc or more because child benefit is now taxed away as income rises between these two points. Someone with two children faces a rate of around 60pc and if you have three children the withdrawal rate rises towards 70pc. Astonishingly, while we consider parents earning just over £50,000 to be rich enough to pay 40pc tax, and to have their child benefit withdrawn, we also consider some 50,000 of them to be poor enough to be entitled to universal credit. They will lose around 80p or more of every extra pound earned.
Meanwhile, the perfectly sensible capital gains tax regime set up by Lord Lawson was undone by Gordon Brown and constantly fiddled with since. The result is that some of those with the very highest incomes, working in private equity for example, face lower effective tax rates than the middle classes paying their 40pc income tax and 2pc national insurance, let alone by comparison with some of the other groups mentioned here.
Reasonable people can disagree over how progressive the income tax system should be. But I challenge any reasonable person to defend the system as it stands today and to claim that what we have is anything other than arbitrary, complex, inequitable and damaging to the economy. We are desperately in need of another chancellor of Lawson’s stature to clear up this mess, and start again.
This article was first published in The Daily Telegraph, and is reproduced with kind permission.