How much tax are you really paying?

With levies on alcohol, fuel, tobacco, flights and spending your tax bill is probably far higher than you think.

How much tax are you really paying? Most of us haven’t a clue.

We might be aware of the highest tax band we fall into, or know roughly how much our Council Tax bill comes to, but we’re highly unlikely to have the faintest idea how much of our income ends up in George Osborne’s pockets.

In fact, our research shows that your real tax rate is likely to be anything up to 48% of your total income!

Shield your savings from the taxman with an ISA

Smoke and mirrors

It’s not surprising that we’re so clueless about the tax we pay, because every aspect of the system seems to have been designed to obscure the reality.

Income Tax alone is split into enough bands to muddy the water. How many of us have ever sat down to calculate how much of our income falls into each band in order to work out what we’re paying? Even then, how many of us forget to add in National Insurance?

Scott Gallacher, Chartered Financial Planner at Rowley Turton (and the top-rated expert on adviser review site VouchedFor) says: “With an increasingly complex tax system (over 17,000 pages compared to Hong Kong’s 276 pages) which has trebled over the last twenty years, how can anyone be expected to understand the myriad of taxes that they pay?

“National Insurance in particular is very misunderstood. The indirect taxes (VAT, Fuel Duty, alcohol duty, and so on) are hidden taxes that people may be aware of but almost no one thinks about having to pay on a daily basis.”

Shield your savings from tax with an ISA

Working out your real tax bill

To demonstrate the effective rates we pay, we asked Gallacher to assess the tax bills of three example case studies.

Dave from Birmingham earns £20,000, and has an Income Tax bill of £1,800 and National Insurance of £1,433. That’s an effective tax on income of 16%.

Susan from Reading is on an income of £32,000, and pays income tax of £4,200 and National Insurance of £2,873. That’s an effective rate of 22%.

Finally, Giles from Surrey earns £60,000, pays income tax of £13,200 and National Insurance of £4,533, so has an effective rate of 30%.

Council Tax and VAT

But income tax and National Insurance are just the first of a huge number of taxes we pay. One of the biggest bills is for Council Tax. For our case studies, the picture varies from Dave - who is still living with his parents and pays no Council Tax, to Susan who pays £1,413 for her Band C property in Reading, and Giles who pays £1,550 for Band E in Surrey.

In real terms, Council Tax bills have been falling for the past few years, while taxes on income have stayed roughly level since 1980. Meanwhile, however, the overall tax bill has shot up. It means that over the past 35 years, various governments have focused on taxing spending.

Take Value Added Tax (VAT), for example, since 1980, the rate has risen from 15% to 20%, and receipts have risen from £16 billion to £22 billion. Again, it’s difficult to work out what VAT we are paying, because the rules are so complicated: peanuts in their shells, for example, are VAT-free, while shelled, roasted nuts attract 20% tax.

It means that although we can speculate that Giles is likely to have more luxuries among his shopping - and therefore pay VAT on more items than Dave or Susan - the complexity of the rules means we cannot say for sure exactly what percentage of their shopping any of our case studies are paying VAT on. 

However, Gallagher says a sensible estimate is that we pay VAT at 20% on around 80% of our shopping.

In our example case studies, this mean Giles pays over £2,100 in VAT, Dave pays just over £1,700, and Susan (who has a young family and a mortgage so has less cash for discretionary spending) has a VAT bill of just over £1,400.

Read: From tampons to ebooks: the strangest things we do and don't pay VAT on in the UK

Sin taxes

All Governments have faced the issue that when they charge tax on something, people cut their consumption of the item in question, and so the tax take falls.

Back in the 17^th century, however, they worked out how to use this to their advantage. Sin taxes are a win-win: either people cut back on things that are bad for them or they carry on consuming them, and raise more money for the Government.

The sugary drink tax is currently on the horizon, but at the moment the key sin taxes are fuel, alcohol and tobacco duty.

Giles does a lot of driving, and pays heavily for it. He spends £200 a month on petrol in his company car, and has an annual Fuel Duty bill of £1,293. Susan, meanwhile, spends £100 a month on petrol - so pays £647 in Fuel Duty and £140 in Car Tax, and Dave doesn’t drive.

Dave does drink though, and that sets him back a fair chunk of tax. He drinks seven pints of beer a week at the pub, and pays the average price of £3.46 - including 44.4p in Alcohol Duty and 20% VAT. It means he pays an impressive £371 a year in beer-related taxes.

Susan has a similar bill, but Giles drinks a couple of bottles of wine a week at home, and as a result his £7 bottles attract just £2.08 duty per bottle, or £121 in a year. None of the case studies smoke.

Rising taxes

The past few Budgets have seen mention of a couple of taxes that before this point few people had any idea they were paying: Insurance Premium Tax and Air Passenger Duty.

All three of our case studies face Insurance Premium Tax on a range of household insurances – which Osborne has raised from 6% to 9.5% since 2015.

Dave is on his parents’ insurance, so has a tax bill of just £4 a year on his travel insurance policy. Susan, meanwhile, pays a total of £126 tax on travel, home and car insurance, and Giles spends £135.

All three also pay Air Passenger Duty. Osborne grabbed some headlines for abolishing this tax for children under the age of 16, but it’s worth knowing that this tax has been rising since it was introduced in 1994 at £5 for short-haul flights and £10 for long haul. It’s now £13 for short haul, and up to £73 for long haul.

Dave and Susan take two holidays and pay £52 each, Giles takes one holiday, and because his children are older teenagers, pays £104. 

The real tax rates

All in all, Dave pays £5,381 in tax (27% of his income), Susan £11,249 or 35%, and Giles £28,676 or 48%.

Giles clearly pays more tax, because he earns more and spends more. With an income of £60,000, he also faces the Higher Income Child Benefit Tax Charge – which is the equivalent of losing all his child benefit for both children (£1,788.80 a year).

It’s these kinds of figures that are used to justify the many times during recent Budget speeches that we’ve heard the phrase that we are ‘all in this together’.

Of course, in reality, Giles is more likely to have the money to spare for tax advice than Dave or Susan, and will tend to find a way to mitigate as much of this bill as possible.

He also has more room in his larger budget to make the kinds of changes that will bring a tax bill down – such as making more pension contributions. Because while we may well all be in this together – many people in Giles’ position will be keen not to be ‘in this’ any more than absolutely necessary.

Shield your savings from tax with an ISA

Don’t miss these:

How to check you're on the right tax code 2016/17

Council Tax arrears: what to do if you can't pay your Council Tax bill

Marriage Allowance: how to get a £432 tax break