What’s better than two types of income tax? Three types of income tax!

(Image credit: © Toby Melville-WPA Pool/Getty Images)

published 7 September 2021

Rejoice. British citizens are about to be treated to a third flavour of income tax.

We’ve already got the original vanilla income tax. We also have National Insurance contributions, which are ostensibly funding your state pension, but, of course, are just another income tax.

And now we’re going to have the wonderfully named “health and social care levy”. With a name like that, who could object to paying it? I mean, it’s not even a tax, it’s a levy. You should feel honoured to pay it!

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Anyway. This tax hike will bring the UK’s tax burden to its highest level ever – 42.4% of national income.

What’s the money going to go on? It’s aimed mainly at two things, one short-term and one long-term. In the short term, the NHS has a massive pandemic backlog to clear up. So some of the money will be used to prevent waiting lists from exploding out of control.

In the long term, we need to find a solution for funding social care. This has been a dilemma that governments have been avoiding tackling for years – the most recent attempt by Theresa May ended up costing her a majority in the 2017 election, for example.

This is a nettle that the government appears to have finally grasped in a slightly ham-fisted manner. A new cap of £86,000 on the amount that anyone in England will need to spend on personal care in their lifetime is being introduced from October 2023.

Also from that date, anyone in England with assets of less than £20,000 will not have to dip into their savings or tap the value of their home to pay for care. (The main residence only counts towards means testing for single people who are going into a care home – so those being cared for at home, or those with a partner can ignore the value of the home for means-testing purposes).

Those with assets of between £20,000 and £100,000 will get some means-tested support. Currently anyone with more than £23,250 has to pay their care costs in full (be aware that this covers care costs, not accommodation costs).

Paul Johnson of the Institute of Fiscal Studies (IFS) think tank isn’t necessarily keen on the way they’ve done it, but he does argue that: “much needed reforms to social care are being introduced and unavoidable pressures on the NHS are being funded through a broad-based and broadly progressive tax increase. That is better than doing nothing.”

So what exactly have they announced to pay for all this and what does it mean for your money?

Being an employee, hiring staff and earning dividends will get more expensive

From April 2022, National Insurance (NI) contributions will rise by 1.25 percentage points. In April 2023, NI will go back to the previous rate, but the new “health and social care levy” will be introduced at a 1.25% rate.

This will also be paid by pensioners who work (whereas previously that wasn’t the case – NI contributions stopped once you reached the state pension age).

Note that, this isn’t just a 1.25 percentage point rise in NI for employees and the self-employed – it’s also going on employers’ NI contributions. In all, notes the IFS, “the combined NICs rate on employment income (including employer NICs) will rise from 22.7% to 24.6%. By contrast, because the self-employed don’t pay employers NICs, their rate rises from 9% to 10.25%.”

In effect, that’s a tax on employment. It might not be as noticeable right now, because we are experiencing a strong labour market and labour shortages. But that extra money has to come from somewhere – just because it’s called employer NICs doesn’t mean the employer actually pays it. The higher cost will either come from higher prices (bad for consumers), squeezed profit margins (bad for shareholders) or from lower wages (bad for employees).

On top of all that, there’s a rise of 1.25 percentage points in the dividend tax. So basic rate taxpayers will pay 8.75% dividend tax (after the £2,000 dividend tax-free allowance – and the £12,570 personal allowance – have been used up). Higher-rate taxpayers will now pay 33.75%, and top rate payers will pay 39.35%.

It’s yet another good reason to make sure you’re sheltering any stockmarket investments in a tax-efficient wrapper such as an Isa or a pension. Although that doesn’t necessarily help those self-employed people who pay themselves in the form of dividends.

The tax system gets ever more complicated and more expensive

As Johnson points out, these moves continue “a trend... of the burden of tax being shifted towards earnings”. A working-age person earning the average UK wage of £28,388 a year will now be paying 20% of their income in total on the three income taxes. A pensioner on the same income will be paying “just 11% – almost half the rate”.

Meanwhile “the creation of an entirely new tax” means the system has been made even more complicated for no good reason.

So overall, the tax burden has increased both in terms of scale and in terms of bureaucracy. We can’t say we’re happy about it. But it’s something we suspect we’ll all have to get used to happening more and more in the coming years.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.