Reduction of basic income tax rate from 22% to 20%

This is the third article in a series on the key UK personal tax changes from April 2008. For the others, please see the introduction.

Basic rate of income tax has been cut to 20%

At last, something to cheer about! The world economy is in turmoil, banks are going belly up, and stock markets are falling, but at least this year will see most UK employees paying less income tax. The exceptions are lower-paid workers who are more affected by the scrapping of the 10% tax band we covered yesterday than by any gain from the cut in basic rate tax.

Some readers were confused why scrapping a tax band will mean an increase in tax. Surely if a tax band goes, they will be taxed less?

If only! What happens is that the income that was previously rated at 10% falls into the next tax band, now 20%.

The old 10% band ring-fenced an initial band of your earnings and taxed them at just 10%. Now all your taxable earnings are either taxed at 20% or 40% (the higher tax rate), except that income excluded by your personal allowances.

Personal income tax bands and allowances in detail

Everyone gets a personal total income allowance, which is the amount of income you are allowed to receive before tax becomes payable. This income includes interest on savings, dividend payments and other earnings, as well as your salary.

Most of us can earn £5,435 in 2008/9 before we start ponying up for Inland Revenue, but the elderly are allowed a little more. The current personal allowances are:

Note: If you’re over 65 and you’re wondering what the income limit is, please see the Government’s personal allowances page. In short it reduces your allowance if your income is above £21,800.

Any income above your allowance is taxed, in 2008/9 at the new 20% rate or the higher 40% rate. Here’s how:

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Note: I’ll keep this table up-to-date in future years, so rates may differ from the article text after 2008/09.

Remember that your income is taxed in ‘chunks’, so if you have total earnings of £50,000, say, only the amount left above the basic rate chunk will be taxed at 40%.

For very comprehensive details of how your income is taxed, you can see the Government’s own personal income tax guide. Otherwise subscribe to Monevator for the rest of my personal tax series.