Three big tax beasts make up 58% of all tax revenue. We examine how the government makes its money and what you can do to save tax.
The news is out – the Treasury recently revealed last year’s records for the tax year up to April 2022. And most taxes were raised from just three sources – income tax, National Insurance and VAT.
Here, we explain how the government makes its money and some simple steps you can take to avoid paying more tax than necessary.
Which taxes raise the most?
Last tax year, from 6 April 2021 to 5 April 2022, the Treasury raised £915 billion a year in tax receipts – a vast sum, greater than the GDP of the Netherlands or Switzerland.
Income tax, National Insurance and VAT together raised around £530 billion, an amazing 58% of all tax revenue. In contrast, corporation tax raised only £68 billion and capital taxes raised £41 billion.
Perhaps surprising is how much National Insurance raises for the government - £161 billion compared with £225 billion for income tax. It’s harder to avoid paying National Insurance as the rules are tougher than income tax and there are fewer rebates available.
In some ways, National Insurance is the forgotten tax. People know they pay at least 20% income tax, but sometimes don’t realise they’re also paying 12% National Insurance. A total of 32% tax is due on earnings between £12,570 and £50,270. In contrast, earnings over £50,270 are charged 42% tax in total (40% income tax plus 2% National Insurance).
Workers can make a big income tax saving if they pay into a pension as their contributions are topped up by pension tax relief at 20%, or 40% for higher-rate taxpayers. In contrast, National Insurance is still usually due on pension contributions and charitable gifts, although there is one little-known way employees can reduce their National Insurance bill: more details below.
Rising tax burden
The tax take is at its highest level as a proportion of GDP since the 1980s and is due to rise more in coming years as an ageing population costs the government more in healthcare and pension costs. The rise in tax take last year was partly due to the economy shrinking during the pandemic, rather than tax receipts increasing, although it’s also part of a longer-term trend.
And the proportion of taxes has also changed over the years. Taxes on the increase include VAT and National Insurance, which have both risen relative to the size of the economy, since 2000. Since the late 1990s, the amount raised by housing stamp duty, capital gains tax and council tax has risen faster than the economy.
Taxes that raise less than they used to include corporation tax, where tax receipts are relatively smaller than they were in 2000. Fuel duties and tobacco duties have also declined over the years.
Who pays the most?
Not surprisingly, more wealthy workers have a much higher tax burden than those on lower incomes. HMRC figures reveal that the top 1% of earners pay 29% of tax, while having a 12.5% share of total income. Official figures show that you’d need to earn above £170,000 to put you in the top 1% of earners.
Likewise, the top 10% contribute around 60% of total tax revenue and earn around 34% of the total UK income. You need to earn over £62,500 to put you in the top 10% of earners.
The Institute for Fiscal Studies (IFS) analysis on income tax, NICs, VAT, excise duties and council tax shows that the 50% of households with the largest incomes contribute around 78% of taxes.
In contrast, although lower-paid workers contribute less to the Exchequer, they do spend a bigger chunk of their income on indirect taxes such as VAT and council tax.
There are many simple ways you can reduce your tax bill, but it’s important not to let the tail wag the dog. Many of these tips may not be affordable if you’re struggling with higher bills and need to spend all your income.
Nevertheless, if you want to reduce your tax bill and can afford to put money aside for the long term, then here are some simple tips:
- Pay more into your workplace pension: if you pay directly into a workplace pension, your contribution is usually made before income tax is taken, meaning you save 20% income tax as a basic-rate taxpayer and 40% as a higher-rate taxpayer. Pensions also have the added benefit that they protect your investments from capital gains tax and dividend tax, so your investments have the potential to grow more than those held in a general investment account.
- Pay more into a private pension: if you pay into a private pension you’ll get 20% tax relief added to your pension automatically. This is also the case if your workplace pension has a “relief at source” arrangement (where your contributions are made after tax is taken). Higher-rate taxpayers will need to claim the extra 20% tax relief through their tax return, or by writing to HMRC at the end of the tax year.
- Remember to claim a tax rebate: as mentioned above, if you’re a higher-rate taxpayer and you’ve made contributions to a private pension or made gifts to charity through a gift aid scheme, you may be due a tax rebate. You’ll need to inform HMRC through writing a letter or filling in a tax return.
- Make extra pension payments to keep child benefit: if you have children and are earning more than £50,000 you may owe a high-income child benefit charge. But it’s sometimes possible to keep your income below £50,000 and hold on to more of your child benefit by making extra pension payments. That’s because the high child benefit charge is based on your net adjustable income after pension payments and charitable gifts. Again, you will have to inform HMRC of private pension payments and charitable gifts.
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- Use your ISA allowances: each year you’re allowed to save up to £20,000 into an ISA. If you invest in a stocks and shares ISA, just like a pension, you’ll protect your investments from capital gains tax and dividends tax charges.
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- Consider salary sacrifice: this works by you agreeing with your employer to give up some of your salary or a bonus and paying the same amount directly into your pension. Salary sacrifice saves on National Insurance, as well as income tax, as you have given up your salary. If you pay £500 each month into your workplace pension, you could save £720 National Insurance each year if you’re a basic-rate taxpayer. Not all employers offer salary sacrifice, but it’s worth asking if they would consider it.
Be careful about timing pension income: you’re allowed to take the first 25% of your pension pot without paying income tax, but after that, income tax will be charged, although pension income is free from National Insurance.
Some people are better off spreading out their pension income, once they’ve taken a tax-free amount, to save on tax. If you’re not sure, then it’s worth getting financial advice as tax rules are complicated and the best course of action depends on your individual circumstances.
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