Please note the charts on this page have not been updated for March 2021 forecast due to a software issue. We will endeavour to update them as soon as possible.

Taxes on different forms of personal income provide the biggest source of revenue for government. In 2019-20 income tax raised £193.6 billion. That represented 23.4 per cent of all receipts and was equivalent to £6,800 per household and 8.7 per cent of national income.

The main reason that income tax is the biggest source of revenue is that personal income makes up the majority of total national income. There are many sources of personal income on which income tax is levied. These include: labour income (the wages and salaries of employees and earnings of the self-employed), income from investments (including interest on savings and the rental income from buy-to-let properties) and pensions income (from both the state pension and any occupational or private pensions).

Income tax is collected in a variety of different ways:

  • for the majority of employees, it is paid via the pay-as-you-earn (PAYE) system. The amount of tax to be paid is calculated by the employer and transferred directly to the tax authorities (HMRC). This is also known as being deducted at source. It means the individual does not need to deal directly with HMRC and that the tax is paid promptly.
  • for some tax payers it is paid via the self-assessment (SA) system. The amount of tax to be paid is calculated by the individual and declared on a tax return sent to HMRC. Tax returns and associated payments are completed after the tax year has ended – in most cases in the following January (so January 2022 for the 2020-21 tax year).
  • other smaller sources of income tax include company income tax, non-SA repayments (for example, when employees have paid too much tax through the PAYE system), investigation settlements and some receipts that cannot be allocated to a particular source.

Some income tax has already been devolved to the Scottish Parliament and the National Assembly for Wales. For more information see our webpages on fiscal devolution.

For most employees, National Insurance Contributions (NICs) are also deducted at source while the self-employed pay NICs via SA.

  Forecast methodology

Forecast process

The OBR commissions forecasts of income tax receipts from HM Revenue and Customs for each fiscal event. The forecasts start by generating an in-year estimate for receipts in the current year, then use different models to forecast growth in receipts from that starting point. We provide HMRC with economic forecasts that are then used to generate the tax forecasts. These are scrutinised in a challenge process that typically involves two rounds of meetings where HMRC analysts present forecasts to the Budget Responsibility Committee and OBR staff. This process allows the BRC to refine the assumptions and judgements that underpin the forecasts before they are published in our Economic and fiscal outlooks (EFOs).

Forecasting models

PAYE income tax

The PAYE income tax model takes our forecasts of employment and earnings and applies an average (‘effective’) tax rate and a marginal tax rate respectively to them to generate a forecast of PAYE tax receipts.

HMRC estimates the effective tax rate on wages and salaries using their Personal Tax Model (PTM) – a micro-simulation model based on a survey of taxpayers’ liabilities. This model calculates the average marginal tax rate on additional income by taking account of reliefs, allowances and our assumptions on inflation and any differences in earnings growth at different points in the earnings distribution. The model then applies these tax rate forecasts to income growth to generate a receipts forecast.

The effects of previously announced policy measures that have not yet been fully implemented, off-model factors such as the effect from incorporations and any new policy measures announced by the Government are then added on to generate our final forecast.

SA income tax

The SA IT forecast starts by splitting up historical tax return data into key income streams (e.g. sole traders’ profits, dividend receipts, savings income, land and property income). These income streams are then projected forward using determinants from our forecasts. Average effective tax rates are then calculated using the same Personal Tax Model (PTM). These average effective tax rates are applied to the forecast income streams to create a SA liability forecast.

SA income tax is generally paid in the financial year after the SA liability arises. To account for this, the SA liability forecast is converted to receipts using timing information from previous years. Future changes to the tax system (announced as Budget measures) and other ‘off-model’ factors are also included in the forecast.

Other income tax

Other minor streams of income tax are forecast in line with historical trends.

Devolved income tax

Income tax devolved to the Scottish Parliament and National Assembly for Wales is forecast by aggregating the relevant whole UK income tax streams and applying an estimate of the share attributable to Scotland or Wales. For more information see our Devolved tax and spending forecasts and Welsh taxes outlook publications.

Main forecast determinants

The main determinants of our income tax forecast are those related to the tax base and those that are used by the Government to set the parameters of the tax system. See the ready reckoners section below for more information on the effects of these determinants on income tax receipts.

Main forecast judgements

The most important judgements in our income tax forecast are related to the economy forecast that underpins it – primarily the outlook for productivity growth and hence earnings growth. Alongside those, we need to make several other forecast judgements. These include:

    • In-year estimate – Our estimate for income tax receipts in the current year is determined by performance of receipts year-to-date, our economy forecast and any other indications from the HMRC model. The in-year estimate determines the base year from which we use our models to forecast receipts growth. For PAYE income tax, it implicitly reflects the average effective tax rate on wages and salaries.
    • Differential earnings growth – Given the importance of the shape of the income distribution for PAYE receipts, we allow for differential earnings growth across it when calculating the average and marginal tax rates for the forecast. The top-end of the income distribution is more ‘tax-rich’ as the average tax rate broadly rises in line with income, so this is an important judgement in the forecast.
    • Assumption on bonuses – PAYE income tax receipts are received disproportionately towards the end of the financial year, reflecting the tax paid on end-of-year bonuses. Our assumptions on financial and non-financial sector bonus growth drive our expectations of these end-of-year receipts.
    • Incorporations – Our PAYE, SA, NICs and corporation tax (CT) forecasts are affected by our assumption that incorporations will continue their rising trend. Employment income is taxed more heavily than profits and dividends, so when formerly employed or self-employed individuals incorporate, their tax bills generally fall and the government loses income tax revenue. (See Box 4.1 of our November 2016 EFO for more detail.)
    • Assumptions about forestalling – The path of SA income tax receipts has been significantly affected by income shifting (largely of dividends) in response to policy measures such as the April 2016 dividend tax rise and the April 2013 cut in the additional rate of income tax to 45p, which created incentives to bring forward income flows ahead of the tax changes taking effect.

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  Previous forecasts

PAYE income tax receipts were significantly weaker than our initial forecasts, in part reflecting weak average earnings growth. But it also reflect movements in tax thresholds that were not factored into our early forecasts (due to differences in inflation and to successive policy measures to raise the personal allowance) as well as the composition of employment gains, which were concentrated in lower paid industries and age groups, where a larger proportion of each individual’s earnings are subject to the personal allowance.

Employment growth was stronger than expected, but was not sufficiently strong to offset the effect of slower growth in earnings. Following the large downward revisions to our economy forecasts in December 2012 and March 2013, PAYE IT receipts were much closer to forecast. The economy forecast was further revised downward in November 2016, since when PAYE IT receipts have performed better than forecast, largely because of stronger earnings growth despite the weaker economy.

SA income tax receipts also fell short of our earlier forecasts. As with PAYE IT, this partly reflected a less tax-rich mix of labour income growth than expected, with more growth through employment and less through earnings. The distribution of incomes, notably for new workers and among the self-employed, was also skewed towards the lower end. Tax thresholds were also higher relative to earnings, initially due to higher inflation but also due to policy-driven increases in the personal allowance. Again, receipts have performed better than forecast since our November 2016 forecast.

The coronavirus outbreak and the public health measures taken to contain it have led to a significant decline in economic activity, and hence total receipts in 2020-21. Income tax receipts have held up well relative to the rest of the economy, in large part thanks to the government’s income support schemes and as employment and earnings for those in the upper half of the income distribution have been less affected. Income tax receipts as a share of GDP have spiked upwards in 2020-21. In cash terms, 2020-21 receipts are marginally up on 2019-20, but the forecast is significantly below pre-crisis paths.

 

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  Policy measures

Since our first forecast in June 2010, governments have announced a large number of policy measures affecting our forecast for income tax. The original costings for these measures are contained in our policy measures database and were described briefly in the Treasury’s relevant Policy costings document. For measures announced since December 2014, the uncertainty ranking that we assigned to each policy is set out in a separate database. For those deemed ‘high’ or ‘very high’ uncertainty, the rationale for that ranking was set out in Annex A of the relevant Economic and fiscal outlook.

Key income tax policy changes since 2010 have included:

    • Several above-inflation increases in the personal allowance. These have steadily increased the amount of earned income that is not subject to income tax. In 2010-11, the personal allowance for those aged under 65 was £6,475 a year. By 2019-20 this had almost doubled to £12,500. If the personal allowance had increased in line with the Government’s stated uprating policy in 2010-11, it would have reached £8,600 in 2019-20 – which is £3,900 (just over 30 per cent) less than the actual threshold.
    • Budget 2021 has frozen the personal allowance at its 2021-22 level for the subsequent four years.
    • Changes to the higher rate threshold. Under the coalition government, the higher rate threshold was lower at the end of the Parliament than in 2010. Subsequently there were above-inflation increases for 2016-17, 2017-18 and 2019-20 to meet the government’s aim of a £50,000 higher rate threshold. As with personal allowances, Budget 2021 froze the higher rate threshold at its 2021-22 level for the subsequent four years.
    • Reforms to pensions and savings policy. These include restrictions to the pensions annual and lifetime allowance, additional pensions flexibility, changes to ISA limits and the introduction of a ‘Lifetime ISA’. Our 2016 working paper ‘Private pensions and savings: the long-term effect of recent policy measures’ sets those changes out in more detail, while our 2019 Fiscal risks report discusses pensions tax relief more broadly.
    • Dividend taxation. Reforms to the taxation of dividend income were made in Summer Budget 2015. The basic, higher and additional rates were raised by 7.5 percentage points and a tax-free allowance introduced on the first £5,000 of dividend income (later reduced to £2,000). We allowed for substantial income shifting ahead of the dividend tax rise.
    • Anti-avoidance measures. Since 2010, the Government has announced a large number of policy measures aimed at reducing the level of tax avoidance and evasion and to enhance the compliance performance of HMRC. These measures have been one of the Government’s preferred sources of revenue-raising in recent Budgets and Spring/Autumn Statements and costing these types of measures is typically subject to considerable uncertainty. Our 2016 working paper Anti-avoidance costings: an evaluation provides more detail.
    • SA deferrals. To help the self-employed manage their cash-flow during the coronavirus crisis, the Government announced measures that allowed taxpayers to defer payments on account and their January 2021 SA balancing payments. Take-up of the schemes was less than expected.

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  Ready reckoners

‘Ready reckoners’ show how our fiscal forecasts could be affected by changes in selected economic determinants. They are stylised quantifications that reflect the typical impact of changes in economic variables on receipts and spending. These estimates are specific to our March 2019 forecast and we would expect them to become outdated over time, as the economy and public finances, and the policy setting, continue to evolve. They are subject to uncertainty because they are based on models that draw on historical relationships or simulations of policy settings. More information can be found in the ‘Tax and spending ready reckoners’ spreadsheet we published alongside our 2019 Fiscal risks report.

The table below shows that:

    • Changes in labour income have a large impact on income tax receipts. Staggered income tax thresholds mean that receipts rise (and fall) proportionately more than changes in labour income, and receipts are more geared towards earnings than employment.
    • Increases in self-employment and other streams of income also feed through into receipts, but with a longer time lag given the self-assessment system which requires taxpayers to file returns by the January after the financial year.
    • The impact of changes in inflation on cash receipts depends on the extent to which inflation feeds through into higher nominal tax bases, in particular wages. Assuming that average earnings growth is unchanged (which might be the case if inflation was pushed higher by import prices or oil prices), higher inflation would reduce income tax receipts. Higher thresholds – which are uprated in line with inflation – mean that less income is taxed at higher rates.

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Other taxes