Income tax: higher or lower?

Craig O'Callaghan examines why each of the major political parties has a different plan for income tax

The next UK general election may still be 15 months away but the battle for votes has already started to intensify, with all three major political parties beginning to outline their differing plans for Britain. One key battleground over the coming year would appear to be income tax, with shadow chancellor Ed Balls announcing plans to reinstate the 50p top rate of income tax should Labour be elected.

The top rate, paid by those earning over £150,000, has been 45p (45 per cent) since the coalition voted to reduce it last April. In a recent speech, Ed Balls accused David Cameron and George Osborne of giving "the richest people in the country a tax cut". The 50p rate was originally introduced by Labour chancellor Alastair Darling in 2010, shortly before they lost the general election.

Why raise the rate?

When questioned about the 50p tax rate, Labour politicians have frequently repeated the mantra, "people with the broadest shoulders should carry their fair share of the burden". With the UK economy still fragile, Labour hope to raise millions of pounds from the tax increase which would assist them in paying off the budget deficit.

However, doubts remain as to whether this policy would actually generate a sufficient level of extra income for the Treasury. Despite Ed Balls's claims that the 50p tax rate raised "almost £10 billion more in tax" over the three years it was in place, an independently verified report by the government states the cut to 45p has only reduced income by £100 million a year.

Furthermore, the Institute for Fiscal Studies announced that the 50p rate would raise less than 1 per cent of what is needed to eliminate the deficit, with the majority of the money needed instead coming from further cuts to public spending.

The main reason for this lack of extra income is that many individuals found ways around the tax rate rise last time it was introduced. Through 'income shifting' tactics such as bringing bonuses forwards or converting income into capital, a significant proportion of the country's highest earners were able to avoid the impact of the higher rate.

Ed Balls's proposal to increase income tax has also been met with disapproval by prominent business leaders, who fear a tax hike would drive investment elsewhere. More than 20 company bosses wrote an open letter to the Daily Telegraph to condemn the plans, while David Cameron warned a 50p rate would be "very bad" for the economy, and would "cost jobs and investment".

Why not lower the rate?

While Ed Balls and the Labour party attempt to convince people that raising the top rate of income tax is the best step forwards, London mayor Boris Johnson has openly expressed a wish to move in the other direction.

"UK income tax is higher than the EU average," said the mayor. "That never used to be the case and I don't know why it should be the case for the long term. Sooner or later there will have to be a new Conservative manifesto and I can't believe we would go into an election pledging to keep our tax rates higher than our competitors."

Despite Boris Johnson's strong views on the matter, David Cameron is yet to confirm whether the Conservatives would seek to reduce the top rate of income tax. The Liberal Democrats, however, have been extremely vocal in their opposition to such a move, with Chief Secretary to the Treasury Danny Alexander saying it would only happen "over my dead body". As a result, any further reduction would seem unlikely unless the Conservatives win a majority in 2015.

With each party intending to handle the top rate of income tax differently, the debate seems set to continue until the polls open next May.