By Naomi Caine, writing for MSN Money, 23/04/2009 00:00

Will Labour get away with the tax hike?

So, the chancellor has come up with a wizard wheeze to drag us out of the financial black hole: tax the rich. It's not a new idea, but will it work?

It's certainly a big black hole. Government borrowing is forecast to reach £175 billion this year, which is more than 12% of GDP. The total debt figure is even more scary; it is expected to rise to 79% of GDP by 2013/14. The UK is also deep in recession, with the economy likely to shrink by 3.5% this year.

Alistair Darling's solution, put forward in his second Budget, is to squeeze the wealthy. The new top rate of income tax for higher earners was not a total surprise; it was trailed in the pre-Budget report in November. But the rate is higher and will be introduced earlier than anyone expected.

Full coverage of Budget 2009

Highest-earners pay more
At the end of last year, Darling warned a 45% top rate of tax for people earning more than £150,000 a year would be introduced from April 2011. Fast forward a few months and the top rate has gone up to 50% and will come into effect in April next year.

It's obviously not good news for the wealthy, especially when it's coupled with the abolition of their personal allowance. Yes, that's changed too. If you earn more than £100,000, your entitlement to earn a portion of your income tax-free will be withdrawn from 2010.

So what's the damage? Well, if you earn £200,000 a year you will currently pay income tax of £69,930. The changes to the tax rate and the personal allowance will boost your tax bill to about £77,520.

The chancellor didn't stop there. His attack on the rich also targeted their pension savings. From April 2011, if you earn more than £150,000, higher-rate tax relief on pension contributions will be restricted, until you get only basic-rate relief if you earn £180,000 or more.

In other words, if you are a high earner and want to pay £100,000 into your pension, it will currently cost you £60,000. In the future, the same contribution will cost £80,000, or an extra £20,000.

Open a self-invested pension

Closing a loophole
And just in case you were hoping to stuff your pension with extra cash ahead of the changes, you can't. The government is swiftly bringing in legislation to prevent such a bonanza.

"The abolition of higher-rate tax relief on pensions is unfair and will act as a disincentive to save for retirement," said Malcolm Cuthbert, a partner at Killik & Co.

"How can it be fair that someone who earns £149,000 will be entitled to 40% tax relief, but someone who earns £150,000 will have some of that relief withdrawn until they get only 20% at £180,000?"

Will it work?
It sounds like political suicide, doesn't it? Tax hikes are rarely welcomed by the public, especially not this close to a general election.

A policy of taxing the rich also represents a full scale U-turn by the Labour party. Tony Blair - remember him? - spent many years and a great deal of energy trying to persuade the electorate, as well as a cynical City, that new Labour was not the enemy of the wealthy.

Of course, Tony Blair is no longer the prime minister and Gordon Brown is entitled to make his mark on the party. But is he also entitled to break a manifesto pledge not to raise income tax before the next election? And does it damage the credibility of the government?

The big picture
Labour has already proved that its economic forecasts are a bit shaky. As recently as November, for example, it was telling us that Britain would be on the way to recovery in the second half of this year. Must we now conclude that its political judgement is not to be trusted?

Well, maybe not. Perhaps the decision to soak the rich is a wise political gambit. It will go down well among Labour supporters and many ordinary people who blame the wealthy for our financial mess. In fact, opinion polls suggest that a tax hike for the rich is a popular move.

The polls reflect the change in politics since the credit crunch. The City has been exposed and we all want to bash the bankers. So it's perhaps politically expedient for the Labour government to revert to type.

Tackling Tories
The move also wrong-foots the Tories. David Cameron and his party will now be under intense pressure to make some sort of commitment to reverse the tax hike and confirm they are the party of lower taxes.

But that's tricky in the current downturn because if you don't raise taxes, you have to cut spending. And the Conservatives don't want a reputation as a party of savage spending cuts.

There's another advantage to the 50% tax rate: it's a headline grabber. And that distracts the public from the rather gloomy economic picture and those frightening borrowing figures.

It's the politics, stupid
If you think about it, there has to be a political reason for the tax hikes because the economic reasons are far from sound.

The new top rate of income tax, for example, will raise an estimated £1.1 billion next year and the pension claw-back a mere £100 million. That's less than the fuel duty increase, which will bring in £1.25 billion.

Effectively, Darling is tapping up drivers for more money than he is taking from the rich.

Remember too that these are estimates from the Treasury. Some commentators, notably the Institute for Fiscal Studies, calculate the extra revenue could be much less.

Will Labour get away with the tax hike? It might initially go down well with the voting public. But if the mood changes, or some of Darling's forecasts prove too optimistic, the tax hikes could start to damage the government's reputation, not to mention the struggling economy.

Poor