The 10% starting rate and changes to personal allowances

The ‘abolition’ of the 10% rate

In March 2007, Gordon Brown closed his last Budget speech as Chancellor with a surprise announcement that he intended to ‘abolish’ the 10% starting rate of income tax. The move was confirmed by Alistair Darling in his maiden Budget on 12 March 2008.

In fact, the 10% rate wasn’t actually ‘abolished’, it just no longer applies to all forms of income. Depending on your circumstances it could still apply to savings and dividend income, but it is removed for earned income as well as property, pension or other income.

The stated purpose of the proposal was to ‘simplify’ the tax system, but it eventually became clear that the effect of taxing earnings income at a 20% basic rate instead of the old 10% rate was that some five million people would lose out. Worse still, most of the losers would be among the UK’s lowest earners.

The 13 May announcements

Faced with fierce media criticism and the threat of a Labour backbench rebellion, on 13 May 2008 Chancellor Darling announced an emergency ‘mini-Budget’, with measures designed to compensate the income tax ‘losers’.

The key announcements were:

• a £600 increase in the personal allowance, from £5,435 to £6,035
• a £1,200 reduction in the basic rate limit, from £36,000 to £34,800.

The measures were implemented in September but backdated to 6 April 2008. They amount to a £2.7 billion tax ‘cut’.

How will the changes affect you?

Basic rate taxpayers:

The measures effectively mean that those earning up to £40,835 will receive an additional £120 this year. Eligible pay packets were boosted by £60 in September, followed by £10 monthly increases until the end of the year.

For example, the effect of the change for a basic rate taxpayer on £30,000 per annum is as follows:

Before:

After:

Higher rate taxpayers:

Individuals currently paying tax at 40% will not receive the £120 ‘windfall’ and are unaffected by the increase in personal allowance.

However those receiving dividend income and currently paying tax at 32.5% could be worse off by as much as £75.

Example – All income from dividends (grossed up figures):

Before:

After: