Jo Bateson (KPMG) considers what the new levy means, what the alternatives were and what other changes we might expect to see in the future.
As a tax practitioner, it is always interesting to see the birth of a whole new tax: the health and social care levy (‘HSC levy’). The prime minster announced that a 1.25% HSC levy will come into effect from April 2022 alongside a 1.25% increase on the dividend tax rate. The HSC levy is estimated to raise £12bn per annum and it will be ring-fenced for health and social care costs. Initially, the HSC levy will be added to national insurance but, from April 2023, it will become its own tax with a separate line on our payslips.
Like many new taxes, however, the HSC levy is not without its controversies. It is not dissimilar to the ‘1p for the NHS’ which was part of the Liberal Party manifesto during the 2017 general election and again in its 2019 manifesto, but this was an additional 1p on income tax and not national insurance – a subtle but important difference.
What do we know about the HSC levy?
The 1.25% will apply to the same income as national insurance, which means earned income such as salary and self-employed profits but not unearned income such as pension, rental or investment income. It will also have the same starting thresholds as national insurance, it will be uncapped and it will fall on employers, employees and the self-employed.
From April 2023, the HSC levy will be distinguished from national insurance and we will see it as a separate line on our payslips and on our self-assessment tax returns for the self-employed. From then, the HSC levy will also apply to those working but above state pension age (in contrast to national insurance which does not apply to earnings after retirement age). Retirement age is continuing to increase as taxpayers look at how to fund their retirement costs including social care. But perhaps with the cap on social care being imposed, those working past retirement age may be able to retire sooner. Time will tell.
The HSC levy is initially being collected through national insurance; I expect this is for speed of implementation. There has historically been a misalignment of the national insurance thresholds with the income tax thresholds, so there are taxpayers who do not earn enough to pay income tax because their income does not exceed the tax-free personal allowance (£12,570 for 2021/22) but who are still liable for national insurance on their earnings above the starting threshold (£9,568 for 2021/22), and from April 2022 they will also be liable to HSC levy. It’s possible that once HSC levy is its own tax from April 2023, the thresholds will be adjusted in line with income tax – although there is currently no indication that this is planned. If the thresholds remain unchanged, it seems likely to affect those on low earnings, who might not have been exposed to a similar increase in income tax. Many of this group may also be affected by the freezing of the tax-free personal allowance for three years announced in March’s Budget as fiscal drag leads to more lower earners coming into the income tax net.
The increase to dividend rates
The prime minister also announced a 1.25% increase on all dividend rates to ensure that ‘those with dividend income, like business owners and investors, will be making a contribution in line with that made by employees and the self-employed on their earnings’. This increases the rates to 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. The tax-free dividend allowance remains unchanged at £2,000 and dividends received through ISAs also remain tax-free.
The Tax Foundation research indicates that the average dividend tax rate in European OECD countries is 23.3%, which would make the UK rate one of the highest apart from Ireland and Denmark. It is important to note that only UK resident individuals pay UK tax on their dividend income so the increase would not impact those investing but not living in the UK. The impact will therefore be felt by those living in the UK and possibly those considering moving to the UK.
For privately owned businesses, the additional 1.25% employers’ HSC levy as well as the increase to corporation tax to 25% from April 2023 will take some time for them to think through especially for those that typically take dividends as well as salary. A dividend tax rate of almost 40% with no corporation tax deduction does seem to make taking dividends from your business an increasingly expensive option.
What were the alternatives?
The prime minister stated that to raise the equivalent £12bn through income tax alone, the income rate would need to be increased by 2% and the burden would fall entirely on the employee or self-employed taxpayer, whereas the burden of the HSC levy is split between the employer and employee. Whether employers pass on the cost of HSC levy to their employees will depend on a number of factors but it is possible that employees may bear the full 2.5% cost of HSC levy, making it potentially a more expensive option than increasing income tax rates.
Another alternative could have been to increase CGT rates. The Wealth Tax Commission suggested in its December 2020 report that doubling CGT rates to align with income tax rates could raise as much as £12bn per year. Although the prime minister specifically stated he would not raise CGT rates for this purpose, it does not, in my view, rule out increases to CGT rates entirely and, with an Autumn Budget due to take place on 27 October 2021, we shall wait and see what the chancellor decides to do.
There was also some media speculation around increases to IHT, but the revenue raised would not be anywhere near the £12bn needed for health and social care. The Wealth Tax Commission reported that even if IHT were radically changed to tax pensions and businesses, it would only increase the annual revenue from £5bn to almost £7bn, which is still £5bn short of the required £12bn annual health and social care costs. However, with a perception in some sections of the public that the new HSC levy might disproportionally impact lower and middle income earners, there may now be increased pressure from some quarters for the chancellor to increase CGT and IHT which are often perceived as taxes of the wealthy.
The future
In October 2020, a MORI polling indicated that 44% of the public would be prepared to pay more taxes themselves to fund public services. However, the most supported method was to introduce a net wealth tax (another new tax!) or increase the taxes on capital. It may be that further tax increases will be announced in the Autumn Budget and with the departure from the manifesto commitment, there is a question as to whether changes to income tax and VAT (the other two taxes which were part of the same commitment) are also being considered. Now that corporation tax rates have already been increased and the ring-fenced health and social care funds have been realised, it’s possible that any further tax changes will be focused on perceived fairness, rather than revenue raising, and we may not see another new tax created this year but we could see reform to our existing taxes, especially capital taxes.
Jo Bateson, KPMG
Jo Bateson (KPMG) considers what the new levy means, what the alternatives were and what other changes we might expect to see in the future.
As a tax practitioner, it is always interesting to see the birth of a whole new tax: the health and social care levy (‘HSC levy’). The prime minster announced that a 1.25% HSC levy will come into effect from April 2022 alongside a 1.25% increase on the dividend tax rate. The HSC levy is estimated to raise £12bn per annum and it will be ring-fenced for health and social care costs. Initially, the HSC levy will be added to national insurance but, from April 2023, it will become its own tax with a separate line on our payslips.
Like many new taxes, however, the HSC levy is not without its controversies. It is not dissimilar to the ‘1p for the NHS’ which was part of the Liberal Party manifesto during the 2017 general election and again in its 2019 manifesto, but this was an additional 1p on income tax and not national insurance – a subtle but important difference.
What do we know about the HSC levy?
The 1.25% will apply to the same income as national insurance, which means earned income such as salary and self-employed profits but not unearned income such as pension, rental or investment income. It will also have the same starting thresholds as national insurance, it will be uncapped and it will fall on employers, employees and the self-employed.
From April 2023, the HSC levy will be distinguished from national insurance and we will see it as a separate line on our payslips and on our self-assessment tax returns for the self-employed. From then, the HSC levy will also apply to those working but above state pension age (in contrast to national insurance which does not apply to earnings after retirement age). Retirement age is continuing to increase as taxpayers look at how to fund their retirement costs including social care. But perhaps with the cap on social care being imposed, those working past retirement age may be able to retire sooner. Time will tell.
The HSC levy is initially being collected through national insurance; I expect this is for speed of implementation. There has historically been a misalignment of the national insurance thresholds with the income tax thresholds, so there are taxpayers who do not earn enough to pay income tax because their income does not exceed the tax-free personal allowance (£12,570 for 2021/22) but who are still liable for national insurance on their earnings above the starting threshold (£9,568 for 2021/22), and from April 2022 they will also be liable to HSC levy. It’s possible that once HSC levy is its own tax from April 2023, the thresholds will be adjusted in line with income tax – although there is currently no indication that this is planned. If the thresholds remain unchanged, it seems likely to affect those on low earnings, who might not have been exposed to a similar increase in income tax. Many of this group may also be affected by the freezing of the tax-free personal allowance for three years announced in March’s Budget as fiscal drag leads to more lower earners coming into the income tax net.
The increase to dividend rates
The prime minister also announced a 1.25% increase on all dividend rates to ensure that ‘those with dividend income, like business owners and investors, will be making a contribution in line with that made by employees and the self-employed on their earnings’. This increases the rates to 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. The tax-free dividend allowance remains unchanged at £2,000 and dividends received through ISAs also remain tax-free.
The Tax Foundation research indicates that the average dividend tax rate in European OECD countries is 23.3%, which would make the UK rate one of the highest apart from Ireland and Denmark. It is important to note that only UK resident individuals pay UK tax on their dividend income so the increase would not impact those investing but not living in the UK. The impact will therefore be felt by those living in the UK and possibly those considering moving to the UK.
For privately owned businesses, the additional 1.25% employers’ HSC levy as well as the increase to corporation tax to 25% from April 2023 will take some time for them to think through especially for those that typically take dividends as well as salary. A dividend tax rate of almost 40% with no corporation tax deduction does seem to make taking dividends from your business an increasingly expensive option.
What were the alternatives?
The prime minister stated that to raise the equivalent £12bn through income tax alone, the income rate would need to be increased by 2% and the burden would fall entirely on the employee or self-employed taxpayer, whereas the burden of the HSC levy is split between the employer and employee. Whether employers pass on the cost of HSC levy to their employees will depend on a number of factors but it is possible that employees may bear the full 2.5% cost of HSC levy, making it potentially a more expensive option than increasing income tax rates.
Another alternative could have been to increase CGT rates. The Wealth Tax Commission suggested in its December 2020 report that doubling CGT rates to align with income tax rates could raise as much as £12bn per year. Although the prime minister specifically stated he would not raise CGT rates for this purpose, it does not, in my view, rule out increases to CGT rates entirely and, with an Autumn Budget due to take place on 27 October 2021, we shall wait and see what the chancellor decides to do.
There was also some media speculation around increases to IHT, but the revenue raised would not be anywhere near the £12bn needed for health and social care. The Wealth Tax Commission reported that even if IHT were radically changed to tax pensions and businesses, it would only increase the annual revenue from £5bn to almost £7bn, which is still £5bn short of the required £12bn annual health and social care costs. However, with a perception in some sections of the public that the new HSC levy might disproportionally impact lower and middle income earners, there may now be increased pressure from some quarters for the chancellor to increase CGT and IHT which are often perceived as taxes of the wealthy.
The future
In October 2020, a MORI polling indicated that 44% of the public would be prepared to pay more taxes themselves to fund public services. However, the most supported method was to introduce a net wealth tax (another new tax!) or increase the taxes on capital. It may be that further tax increases will be announced in the Autumn Budget and with the departure from the manifesto commitment, there is a question as to whether changes to income tax and VAT (the other two taxes which were part of the same commitment) are also being considered. Now that corporation tax rates have already been increased and the ring-fenced health and social care funds have been realised, it’s possible that any further tax changes will be focused on perceived fairness, rather than revenue raising, and we may not see another new tax created this year but we could see reform to our existing taxes, especially capital taxes.
Jo Bateson, KPMG
