Income Tax - Explanation

Income tax is very familiar (and perhaps disliked!) by all who work, but many people do not understand fully how it is charged. It is an important tax to the government as it is its main revenue-raising tax, though despite that it only represents just over a quarter of total tax revenue. National Insurance and VAT come fairly close on the list in terms of importance.

Over 25 million individuals pay income tax in the UK, but not all income incurs tax. The main kinds of income upon which income tax is levied are pay, pension payments upon retirement, unemployment benefit, profits from business, income from property, bank and building society interest and dividends on shares. Income tax is not paid on certain privileged savings products such as National Savings Certificates.

The structure of income tax in the UK operates via a system of allowances and bands. All individuals have a personal allowance which is deducted from total pre-tax income in order to get to the taxable income. In other words, the first bit of their income is tax-free. The rest of a person's income is then taxable and is subject to different tax rates depending upon the 'tax band' that income falls within. The figures for 1990/2000 are given in the table below. In addition to their personal allowances, a married couple is eligible to a 'married couple's allowance' - a bit more tax-free income. So there are advantages to being married! However, that advantage will be removed after April 2000. This abolition of the Married Couples Allowance was announced in the 1999 Budget.

Income tax allowances 1999/2000	£	Income tax rates 1999/2000	£ of taxable income
Personal allowance	4,335	Lower rate - 10%	0 - 1,500
Married allowance	1,970	Basic rate - 23%	1,501 - 28,000
Blind person's allowance	1,380	Higher rate - 40%	Over 28,000

In the 1999 Budget, the Chancellor announced that the basic rate of tax will be reduced to 22% in April 2000.

Tax is collected by the Inland Revenue on what is called a 'cumulative basis'. This means that a person is taxed on the basis of what they are going to earn in the whole year and not just month by month. Most tax in the country is collected by the PAYE or 'Pay As You Earn' system. This means that employers deduct the tax directly out of a person's wages and give it to the Inland Revenue on their behalf - generous, huh?!