The Adam Smith Institute is behind the concept of Tax Freedom Day, a day each year that is starting to grab the attention of taxpayers across the UK. This day demonstrates how much time we have to work to cover taxes for that year. While we await the calculations for 2024, there is plenty of information about 2023 and previous years to demonstrate the concept.
Looking back at the 2023 data, the average taxpayer worked until 18th June (or 169 days) to cover taxes for the whole year.
How has Tax Freedom Day changed over the years?
As with any economic indicator, Tax Freedom Day has been volatile over the years. To give you an example, when the concept was first introduced back in 1995, it was 4th May. So, up to this date, all income earned by the average working individual would cover their annual tax liabilities.
In 2008, we saw the first peek at 28th May before the financial crisis emerged, leading to a fall to 18th May in 2009. It was not until 2021 that this peak was breached, with the Tax Freedom Day extended to 29th May, after which the figures (and the expected figures) took on a sharp upward trajectory. By 2026, the date is expected to extend until 24th June, which is a significant jump from the last figure in 2023 of 18th June.
So, since the introduction of Tax Freedom Day, if all of our income was used to pay off our annual tax liabilities, we have moved from 124 days to 169 days. That is a significant jump that could extend another six days (and probably more) in the short term.
The information required to calculate Tax Freedom Day is readily available today, but extrapolating data for 1995 shows we are working longer than the previous highs of the 1980s. This was a period of significant economic growth, although, towards the end of the decade, we saw the stock market crash and resulting recession.
Calculating the Tax Freedom Day
As the figures used to calculate Tax Freedom Day are deemed for an "average" taxpayer, the actual situation will vary for all of us. There is no such thing as an average taxpayer, but there are figures we can use to show how long we need to work just to pay our tax liabilities. It's important to remember that while income tax is a major element of our tax liabilities, VAT and other taxes are also influential.
Scenario
Year: 2023
Net national income: £1.95 trillion
UK taxpayer contributions: £901.8 billion
Using these figures, we can calculate:
Taxpayer contribution to net national income: 46.25%
This equates to: 169 days
Tax Freedom Day: 18th June 2023
Another calculation we can consider is the "Cost of Government Day," which takes into account government borrowings. In this situation, the Tax Freedom Day would be extended to 15th August, the 227th day of the year.
As you can see, adding tax liabilities and issues such as the cost of running the government doesn't leave an awful lot for our personal living expenses. Consequently, it is critical that you make full use of your allowances and tax-efficient investment vehicles.
Is there light at the end of the tunnel for UK taxpayers?
Unfortunately, the statistics do not make good reading for UK taxpayers at this moment in time. The government's wider tax take as a percentage of GDP is now at levels not seen since the 1940s, and there are concerns that it could go higher before falling. There are several factors to take into consideration, such as:-
- Economic growth
- Government debt
- Covid related funding (still being repaid)
Interest rates are expected to fall later this year (possibly as soon as June). While the economy was surprisingly strong in the first three months of 2024, it isn't easy to forecast too far ahead with great confidence. Unfortunately, several recent UK government budget changes will add to individual tax burdens in the short term.
Fiscal drag
You may have heard of the term "fiscal drag," which is a smoke-and-mirrors strategy that avoids a direct increase in tax rates but increases the government's tax income. These two points may seem at odds, but unfortunately, fiscal drag is a very successful fundraising strategy for the government.
Income tax
The best way to demonstrate the impact of fiscal drag on income tax receipts is to show two different scenarios.
Tax year: 2023/24
Gross salary: £12,000
Personal allowance: £12,570
Taxable element: £0
Income tax liability: £0
To demonstrate the impact of fiscal drag, we will assume that wage inflation matches general inflation, which in this scenario is 10%. Typically, the income tax personal allowance is increased annually by the rate of inflation, with the figures for the following tax year (normally) looking like this:-
Tax year: 2024/25
Gross salary: £13,200 (an increase of 10%)
Personal allowance: £13,827 (an increase of 10%)
Taxable element: £0
Tax liability: £0
Using fiscal drag, the personal allowance is frozen even though the rate of inflation is 10%. Therefore, the revised income tax figures are as follows:-
Tax year: 2024/25
Gross salary: £13,200 (an increase of 10%)
Personal allowance: £12,570 (no change)
Taxable element: £630
Tax liability (20%): £126
To put this into perspective, increasing wages in line with inflation only maintains your relative spending power. While we are presenting this in simplistic terms if your cost of living increases by 10%, then a 10% increase in income means that you can still afford the items, services, and additional spending associated with your living expenses. However, due to fiscal drag, the individual moves beyond the personal allowance and is paying tax on £630 of their income in the above situation.
Therefore, net income falls to £13,074 (after income tax), which equates to a net 8.95% increase. As this is below the 10% inflation rate, relative spending power has fallen by 1.05% over the year. If this scenario continues for three years, your gross income would increase to £15,972, maintaining your relative spending power.
However, due to the freezing of the income tax band, you would be taxed at 20% on the balance above the allowance. At the end of year three, this equates to a 20% charge on £3402, creating a tax liability of £680, effectively reducing your spending power.
Due to fiscal drag, it is estimated that 1.7 million people paid tax for the first time in 2023, and 1.4 million were pushed into the higher-income tax band. Consequently, according to the Office for Budget Responsibility, the number of people paying the 40% tax rate will increase from 5.3 million to 6.7 million.
Dividend income
In the 2024/25 tax year, the dividend tax allowance will fall to £500 for each individual. This is a significant reduction from the £5000 figure of 2016, reduced to £2000 in 2018, £1000 in the last tax year and today's figure of £500. This means that more of your unsheltered dividend income (from investments outside of pension funds, ISAs and other tax-efficient investment vehicles) will be taxed.
Even though the dividend tax rate is less than income tax, it is still an additional charge for many as the allowance has been continually reduced. The rates are as follows:-
- Basic rate taxpayers 8.75%
- Higher rate taxpayers 33.75%
- Additional rate taxpayers 39.35%
In isolation, this increase in dividend income liabilities may seem relatively moderate. However, considering the array of other changes in recent years, the cumulative impact is significantly eroding net income and increasing tax liabilities.
Capital gains tax
It is an understatement to suggest we have seen major changes in capital gains tax in recent years. In the 2022/23 tax year, the individual allowance stood at £12,300 and was a significant element of long-term tax planning. While still useful, this was reduced to £6000 in the 2022/23 tax year and just £3000 for the 2024/25 tax year.
As a consequence, a greater element of capital gains will be taxed in the future, although this does highlight the value of pension funds, ISAs, and other tax-efficient investment vehicles.
Inheritance tax
Many people view inheritance tax as a political hot potato, which will be one of many topics discussed as we approach the General Election on July 4th. The reality is that the relative value of the inheritance tax allowance has been diminishing since April 2009, when it was frozen at £325,000. This freeze was originally intended to last until 2026 but has recently been further extended to 2028.
The inheritance tax allowance currently shelters the first £325,000 of an estate's chargeable assets from inheritance tax. Those valued in excess of the allowance will be liable to a 40% charge on the surplus amount. Due to the freezing of the allowance in 2009, more people are now facing inheritance tax on their estates.
To put this into perspective, with the average UK home valued at £281,000, an element of additional assets, investments, and savings could see many easily breach the threshold.
If the threshold had been increased in line with inflation between 2009 and 2023, it would now stand at £483,812. Compared to the figure today, this is a £158,812 shortfall; therefore, an estate worth £483,812 will face a £63,524 inheritance tax liability, which would not have occurred if the allowance had increased in line with inflation.
Planning for the future
It is only when you see the figures in black and white that the extent to which personal tax liabilities have increased in recent years becomes apparent. Working the first 169 days of the year to cover your annual taxes puts everything into perspective, and the fact that this is set to increase is of obvious concern.
Taking a broader view of your finances, this topic highlights the need to plan ahead and use all of your annual allowances where applicable, as well as tax-efficient investment vehicles such as ISAs, pensions, etc.
Get in touch with Scott Kingsley
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