National Insurance will increase by 1.25% in April after the prime minister ended speculation that the idea could be shelved due to the UK’s cost of living crisis. Penning an article in a Sunday newspaper, Boris Johnson described the hike as ‘the right plan’.
So with the tax burden on working income set to increase in just over two months, let’s explore the wider question of why working income is taxed at a higher rate than wealth in the UK.
[top_pitch]
What’s happening with the National Insurance hike?
From 6 April, employees, employers and the self-employed will all have to pay 1.25% more in National Insurance. If you earn less than £9,564 a year, then you don’t pay National Insurance. Those aged 66 and over also don’t pay the tax.
The amount of National Insurance you pay depends on your income and the type of contributions you make.
National Insurance is a regressive tax as the percentage you pay decreases if you earn over a set threshold. For example, it’s charged at 12% on income between £9,568 and £50,284, and reduces to just 2% on working income above this.
It is for this reason that many see the upcoming National Insurance rise as unfair, given that pensioners don’t pay it, and the fact that many lower earners will have to pay more (in percentage terms) than higher earners.
The National Insurance hike will only apply for one year. That’s because from the 2023/24 tax year, it will be replaced by a new Health and Social Care Levy.
How does tax on working income compare with tax on existing wealth?
Many see the National Insurance rise as unfair, given that many low earners will be impacted. However, the upcoming hike has also led to many questioning why tax on working income is taxed at a higher rate than wealth derived from non-working income, such as stocks, shares and rises in property values.
Let’s take a look at how differently income and wealth are taxed in the UK.
Tax on working income – up to 45%
If you live in England, Wales or Northern Ireland, you face a maximum income tax rate of 45% (if you earn £150,000 or more). If you don’t earn such a high amount, you still have to pay a hefty 40% tax if you earn over £50,271, or 20% if you earn less than this, but more than £12,571.
Tax on dividends – up to 38.1%
The maximum tax applied to dividends is 38.1%. This rate applies to those with dividend income in excess of £150,000.
For those with dividend income between £37,701 and £150,000 the tax payable decreases to 32.5%. Dividend income between £2,000 and £37,700 is taxed at just 7.5%.
Share dividend tax will increase by 1.25% in April. However, if you stash your investments in a stocks and shares ISA, you can avoid paying any share dividend tax.
Tax on capital gains – up to 28%
The maximum capital gains tax that applies to property is 28%. For other assets, such as stocks and shares, it’s 20%. These rates are only payable if the gain is in excess of £50,270.
However, between £12,300 and £50,270, capital gains tax is charged at 18% on property and 10% for other assets. Any increase in wealth below £12,300 is tax free.
Tax on stocks and shares can be swerved entirely by putting investments in a stocks and shares ISA.
[middle_pitch]
Why is work taxed more than wealth?
Even after putting aside the upcoming National Insurance rise, it’s clear to see that the UK has a preference for taxing working income rather than wealth acquired from other sources.
This is arguably unfair, given that working income is derived from ‘blood, sweat and tears’, whereas income derived from rising property values, stocks, shares or inheritance is essentially ‘unearned.’
Despite these concerns, the higher tax burden on workers isn’t likely to change any time soon. That’s because the current tax system in the UK is largely driven by politics.
For example, it can be argued that many pensioners, and those with existing wealth, are happy with the current status quo. That’s because pensioners typically don’t pay income tax or National Insurance, while wealthy individuals with lots of assets are happy for the tax burden to fall on workers.
As a result, any political party that suggests changing the current tax system is likely to be punished. That’s because pensioners vote in large numbers, while asset-rich individuals have been known to make generous political donations. Perhaps this is something to bear in mind when you look at your next payslip!
Please note that tax treatment depends on your individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
