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This help file reflects the tax and benefit system as it was after the April 2002 Budget (except for the tax credits, which are based on the system due to come in to place in April 2003).

Income Tax Personal Allowances

Income tax in the UK operates through a system of allowances and bands of income. Each individual has a personal allowance, which is deducted from total income before tax in order to reach taxable income. Taxpayers under 65 years old receive a personal allowance of £4,615, while older people are entitled to higher personal allowances. If income for the over-65s exceeds a certain limit (£17,900), then the allowance becomes subject to a taper of 50% which gradually reduces it to a minimum level equal to the allowance for the under-65s. Persons aged 65 to 74 receive a higher personal allowance of £6,610, while those aged over 75 are entitled to an allowance of £6,740.

Income Tax Rates

Taxable income is subject to different tax rates depending upon the 'tax band' that income falls within. The first £1,920 of taxable income (i.e. income above any personal allowances) is taxed at a lower rate of 10% (prior to April 1999, the lower rate was 20% but applied to a wider band of income). The next £27,980 is subject to the basic rate of 22%. For taxable income above the basic-rate limit of £29,400, that portion of income is taxed at the higher rate of 40%.

Indexation Provisions

In the budget, the Chancellor normally increases the tax allowances and bands to allow for inflation.

Examples of Income Tax Calculations

The following examples show how bills are determined under the current income tax system.

1. A person earning £4,000 per year.
   The personal allowance is £4,615 so no income tax is paid.
2. A single person on an income of £15,000 per year.
   The personal allowance is £4,615 so taxable income is £10,385 The lower rate of income tax, 10%, is paid on the first £1,920 (£192) and 22% on the remaining £8,465 (£1,862.30) giving a total income tax bill of £2,054.30 (£192 + £1,862.30).

National Insurance

Payment of National Insurance contributions entitles individuals to receipt of certain social security benefits. In practice, payments from and receipts into the fund bear little relation to each other for any individual contributor. In the National Insurance system, current contributions finance current benefits, with the fund merely being a device to prevent cash-flow problems. Officially, the fund should not fall below one-sixth of National Insurance expenditure. Historically, this has been achieved through a grant from central taxation, although during the mid-1980s the high level of economic activity expanded contribution levels, resulting in the grant being abolished in 1990. The subsequent recession reduced contributions and raised the costs of benefits so that the grant had to be reintroduced in 1993-94. It subsequently declined and the fund is now in surplus.

In 2002-03, National Insurance contributions are forecast to raise some £66 billion, of which the vast majority is raised by Class 1 contributions. Class 1 contributions are paid by two groups: employees as a tax on their earnings and employers as secondary contributions on those they employ. Since 1975, Class 1 contributions for both employers and employees have been earnings-related, subject to an earnings floor which until 1999 was the Lower Earnings Limit (LEL). In 1999 the level at which employers starting paying NI (the secondary threshold) was increased to the level of the income tax personal allowance, while the income over which employees are liable for NI (the primary threshold) increased more slowly. The two were aligned in April 2001. Nevetheless, the Lower Earnings Limit remains in place - no longer as the income at which NI is payable, but as the income from which an individual becomes entitled to receive social security benefits that previously required NICs to be paid. The rationale is that individuals who would have been entitled to these benefits before 1999 should not lose this eligibility due to the over-indexation of the NI earnings floor.

Our model allows changes to employees NI only. The system is as it will be from April 2003, as pre-announced in the April 2002 Budget.

Employees' Contributions

Contracting Out

Value Added Tax

Firms pay VAT on their sales but claim back the tax implicit in the costs of their inputs. Therefore, the net tax paid is on the "value added" by the firm to the good or service, that is, the difference between the sum of the prices they paid for materials and other inputs, and the price they charge for the final good or service.

Zero-Rated Goods

• Most food (not alcohol, soft drinks, confectionery and crisps and meals out)
• Construction of new dwellings
• Domestic passenger transport
• Books, newspapers and magazines
• Medicines on prescription
• Children's clothing

VAT-exempt Goods

• Rents
• Private education
• Health Services
• Postal services
• Finance and insurance
• Burial and cremation
• Betting, gaming and lottery

Excise Duties

Vehicle Excise Duty

State Benefits and Tax Credits

In 2001-2002, over £100 billion was spent on social security benefits in the UK. This amounts to just under £1,700 for every man, woman and child in the country, and represents 30 per cent of total government expenditure (10.7 per cent of GDP). The Department of Social Security spends by far the largest individual share of total expenditure of any government department, with the next largest being the Department of the Environment, Transport and the Regions (DETR) at 12.9 per cent of government spending.

Over 30 million people in the UK receive income from at least one social security benefit, well over half the total population.4 For means-tested benefits such as income support, receipt of the benefit will depend upon the income of the claimant and their personal characteristics such as age and family type. For contributory benefits such as incapacity benefit, eligibility for payment depends upon the claimant having paid sufficient National Insurance contributions (NICs) during their life. NICs are made by all employees whose earnings are above £76 per week (known as the primary threshold, PT), although the government credits those earning between £67 (known as the lower earnings limit, LEL) and £76 with contributions. Some benefits, such as child benefit, are neither contributory nor means-tested and are universally available to all people who meet some qualification criteria.

All benefits require some residence conditions to be met, generally that the person be present and resident in the UK, although there are different degrees of 'residence' required for different benefits. By and large, people 'subject to immigration control' are unable to claim benefits (i.e. people who require leave to enter or to remain in the UK but do not have it). As the UK was a signatory to the 1951 UN Convention on the Status of Refugees, refugees in the UK have the right to claim certain benefits such as income support. The Asylum and Immigration Act 1999 removed asylum seekers from mainstream benefit payments, and they now have payments administered by the National Asylum Support Seekers.

Tax Credits

Tax Credits form an increasingly important part in the British tax and benefit system. It's hard to define exactly what constitutes a tax credit, but you can think of them as somewhere between a tax allowance and an income-related benefit such as Income Support (the main benefit for low-income familes not in work). The model allows you to experiment with the system of tax credits as it will be from April 2003. A new system comes in then, though much of it is the same as the previous system, but with new names and different administrative arrangements. A summary and full details of the new credits are available from The Treasury.Details of the system these new credits replace are available from the Inland Revenue.

• Child Tax Credit (CTC). This is rolls up into one system all income-related support for children. Despite the name, it will actually be paid in cash to the main carer (usually the mother) of the children, rather than through a reduction in tax payments. Compared to the pre-2003 system, CTC incorporates the child elements of Working Families' Tax Credit and Income Support, as well as the Children's Tax Credit (a small tax credit previously paid to all families with children who paid income tax, but at less than the higher rate).
• Working Tax Credit (WTC) reduces the tax payments of low-paid workers. All families with children with a family member working over 16 hours per week can qualify, depending on their income. A new feature is that childless people aged over 25 and working full-time (30 or more hours per week) can also qualify.

The credits work by calculating a maximum credit (amount payable) given the families' circumstances. There are credits for the presence of children, family size, hours of work as well as other circumstances such as disablement and age. This maximum credit is then reduced if the families'income exceeds an Income Threshold, the reduction being some percentage of the excess of income above the threshold.

For a family with 2 children and at least one person working over 30 hours per week, and earnings (after tax and National Insurance) of £250p.w, the calculation goes as follows:

Childless people working 30 hours and over per week can qualify for the Basic Element of Working Tax Credit component but not the rest. Childless couples also qualify for the couples' and lone parent element. Unemployed families with children qualify automatically for the child elements of the Child Tax Credit as part of their Income Support. There are additional payments possible for over 50 year olds, for the disabled, and for child care, but these are not modelled in Virtual Economy.

The Tax Credit elements you can model in Virtual Economy are:

• Working Tax Credit: Basic Element (currently £29.20p.w.). Increase this to increase the generosity of WTC to everyone, including the childless.
• Child Tax Credit: Family Element (currently £10.45p.w). Since this is only tapered away on incomes greater than £50,000 p.a.,increase this if you want to increase incomes of (almost) all working families with children, except the very richest.
• Child Tax Credit: Child Element (currently £27.75p.w.). Increase this if you want to specifically help low paid families with children.
• Child Tax Credit: First Income Limit. (£97p.w.). This is the level of income above which WTC and CTC start being withdrawn. Increase this if you want richer families to qualify for these benefits, but for them to be worth the same amount as at present to the lowest paid amoungst the families who currently qualify.
• Child Tax Credit and Working Credit: Withdrawal Rate. (currently 37%). Your CTC and WTC are withdrawn by 37p for every £ you earn above the first income limit. Lower this if you want these benefits to taper away more slowly, so more families qualify and those who already qualify but whose income is above the income limit receive more benefit.

Child Benefit

Government Spending

Go to the policy tools section for more on this.

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