What Tax Freedom Day means for you

You could say it’s time to celebrate! And I am not talking about the Queen’s Diamond Jubilee.

Today is the UK’s Tax Freedom Day (TFD). This marks the date by which the average Briton will have earned enough money to pay his or her annual tax bill. So after today, you start working for yourself rather than for the government.

Sound good? Actually, as I’ll explain, the more you look into the way we pay for the government’s take, the less happy you’re likely to be.

But there are ways to fight back.

How TFD is worked out

Since 1991, the timing of Britain’s TFD has been figured out by the Adam Smith Institute.

It tots up all the direct and indirect taxes, along with National Insurance contributions (NICs), we pay to HM Revenue and Customs. Of course, those of us in the pay as you earn (PAYE) system must hand over our tax and NICs each month, but the Adam Smith Institute adds these into the mix.

Then it looks at our national income, and it works out what proportion is needed to satisfy the demands of the government’s tax gatherers. That allows it to calculate the total number of days, including weekends, that the average UK earner must work to pay all fiscal outgoings.

The fact that UK TFD falls on 29 May means that in 2012, almost 41% of your overall income will be ending up in the taxman’s coffers (the proportion of the year that falls between 1 January and 29 May).

We don’t yet have a full 2012 breakdown of how the government is currently relieving you of your hard-earned money, but historically, paying income tax bills alone has required an average of over 40 days’ work a year, and paying VAT has taken more than 20 days’ work.

It’s worse than it looks

In fairness, TFD in 2012 has occurred at a similar point over the last few years. This suggests our overall tax burden hasn’t been increasing as much as expected. But there’s a missing factor here – as well taxing us heavily, our government is still borrowing at record levels.

This debt must be repaid at some stage, and both current and future taxpayers will have to pick up the tab. So we need to look, says the Adam Smith Institute, at the real ‘Cost-of-Government Day’.

That’s the date by which we’ll have worked enough to pay for both the government’s spending and its borrowing. It won’t be until around the 23rd June, says the Institute. The TaxPayers’ Alliance has also crunched the numbers, and it’s even gloomier: earlier this year, it said 2012’s Cost of Government Day won’t fall until 26 July.

Put another way, taxpayers will have to work until their summer holidays just to pay off their share of the total costs incurred by the government.

Indeed, last week saw the latest news on this score. April’s official figures for Britain’s public finances may have looked good on the surface, but they were boosted by a one-off technicality with the Royal Mail pension fund. Strip this out, and the underlying government borrowing number was £11.5bn; this compares with last April’s £9.1bn.

That’s “pretty nasty”, says Vicky Redwood at Capital Economics. And it “provides more evidence to suggest the trend in public sector borrowing has deteriorated since the start of the year”.

 

What does this imply for future TFDs?

Britain is still at the mercy of foreign lenders; they’re vital in providing the money we need to pay our bills.

So far, the government has talked a good game about slashing the budget deficit through a mix of austerity and higher taxes. This has so far done the trick in that the UK can now borrow money over ten years at just 1.75%. Britain is seen as safe compared to the eurozone.

But if outside investors get the jitters that our state debt is growing fast again, we’ll have to pay more to borrow. That’ll drive our debts even higher. The government can’t let that happen, so it must do whatever is needed to curb borrowing and keep foreign lenders onside.

Sure, imposing higher taxes may be counter-productive because more people will try to dodge them, but cutting public spending is proving tough. That means overall taxation is more likely to rise than fall.

As I said earlier, the more you look at TFD issues, the less rosy the picture appears. The real TFD message is that in future, we’re all likely to be working longer hours to fund our tax payments.

How you can fight back

The good news is there are two things you can do.

First, make sure you’re not paying more tax than you need. The latest Tax Action report from unbiased.co.uk on reveals we’re set to waste £12.6bn in ‘preventable’ tax payments this year. This translates into a whopping £421 being wasted by each individual taxpayer.

So check what you could save – there are some good ideas here.

Second, generate more income to help pay your tax bills – especially if there’s a tax advantage. Earlier this year, my colleague Phil Oakley ran the slide-rule over high-yielding preference shares, known as ‘prefs’. Prefs are safer than ordinary shares as they rank higher in the pecking order when a company is paying dividends.

As Phil noted, insurer RSA has a preference share whose dividend is covered 38 times by after tax profits. And since then, prices in the pref market have dropped along with the stock market, so yields have risen. You can now pick up the RSA 7 3/8% on a yield of 7.2%.

And here’s the good news on the fiscal front: pref dividends are taxed like ordinary share dividends, so UK basic-rate taxpayers can keep all the payout they receive, ie they don’t have to fork out any extra tax.

Category: Economics