The 10p flip: heads you win, tails you lose

Alistair Darling's sudden and unexpected changes to the tax rate raised as many questions as they answered. Tony Levene looks at who gains - and who doesn't
Gordon Brown's head on a 10p piece at Banksy exhibition
Photograph: Tim Ireland/PA

Ten pee or not ten pee, that was the question. For weeks the government denied it would do anything - or needed to do anything - to help the 5.3m families who were worse off from the start of this tax year last month as a result of the scrapping of the 10p-in-the-pound tax level.

But then earlier this week chancellor Alistair Darling came up with a surprise rescue package. In an unprecedented change to the rules after the start of the tax year, he made some deft alterations to tax allowances and the threshold at which taxpayers move from basic 20% income tax to the higher 40% rate. But the chancellor's surprise move still leaves winners and losers.

Here's our guide to the tax row that became a water-cooler topic for those who normally wouldn't know their VAT from their inheritance tax - or care.

Who were the losers when the 10p rate was scrapped?

· Women pensioners under 65 - they could not claim working tax credits

· Students with part-time jobs who would not be able to claim a tax credit

· Other part-time workers on less than 30 hours a week - no tax credits for them as you have to be a full-timer

· Lower-paid people whose partners are higher earners who could not claim working tax credits either, and

· Under-25s without children.

Overall, you could have earned up to £18,000 and lose, but those left worst off were on around £10,000 a year.

Did anyone gain?

Yes. Because the basic-rate tax was cut from 22% to 20%, those earning from around £18,000 to about £41,000 a year paid less tax, gaining up to £8 a week. And many lower-paid workers were compensated for the loss of the 10p band by increases in tax credits.

What is the new income tax deal?

After toying with and rejecting ideas such as forcing employers to pay a higher minimum wage or adjusting the winter fuel allowance for the over 60s, the solution was simple.

The chancellor lifted the personal allowance for those under 65 by £600 from £5,435 to £6,035. This reduces tax bills by 600 times 20p or £120. This was intended to recompense the average amount that was lost by getting rid of the 10p tax band.

Does that mean everyone gets £120 a year more?

No. It's restricted to those paying basic-rate tax. Those paying top-rate tax - the 40% level - will not get the bonus tax rebate payment.

What will happen is that the starting level for top-rate tax is reduced by £600 to compensate for the extra £600 given as a personal allowance.

The new "threshold" for higher-rate tax will now be £40,835 instead of £41,435. Those earning between the old and the new thresholds will gain part of the £120 extra a year.

What about the winners from the change from 22p tax to 20p?

Raising the personal allowance was a blunt instrument. It will benefit all those with total earnings under the top tax rate threshold. So those earning from £18,000 to £41,000 win twice over - they have already gained from the basic-rate tax reduction and now they are set to profit again from the £120.

And those who can apply for tax credits (such as lower-earning families) will also do well. They will get to keep the promised tax credit increases but also gain from the £600 increase in the personal allowance level when income tax starts.

If some win twice over, are there those who are still worse off?

Yes. Anyone earning around £6,700 to £10,000 a year and who cannot claim a tax credit still has a slimmer pay packet than if the old system had been left in place. In some cases, they could be losing £2 a week compared with last year. So while the better off do even better (see question above), the least well off do the least well. But no one goes further into financial loss as a result of these changes.

When will taxpayers see all this in their salary slips?

The idea is to pay six months' worth of the £120 rebate - £60 - in September salaries. The balance will be paid at £10 a month until March. HM Revenue now has the massive job of sending employers and employees new PAYE coding notices. This could cause problems as, based on previous experience, many coding notices might be wrong.

Is national insurance affected?

No. Employees will still pay national insurance - a tax in all but name - at £105 a week or £5,460 a year. This is now £575 a year below the new starting level for income tax. The government has said it intends to synchronise the lower earnings level where national insurance starts and the higher level where it ends with basic-rate tax.

What about those over 65?

The budget already increased the "age related" personal allowances of most aged 65 and over by more than enough to offset the loss of the 10p level. Those aged 65 to 74 can earn £9,030 before paying tax, while those 75 and over have a tax-free allowance of £9,180. Last year the levels were £7,550 and £7,690 respectively.

Older people towards the top of the pay and pensions scale lose this "age related allowance", which starts at earnings of £21,800. But at this level, they are already well over earnings levels where the 10p abolition would impact. But providing they are not 40% tax payers, they will gain at least £120.

Who is paying for all this?

The complete package announced this week is to cost £2.7bn. This will be raised by increased government borrowing so eventually everyone will contribute to its repayment. The Liberal Democrats believe that only £630m will go to those who lost out - the rest will go to those who were already ahead.

Is this new scheme set in stone?

No. No one can be certain of anything in the tax world and chancellors do change their minds. Gordon Brown, when he was chancellor, both introduced and abolished the 10p rate.

There are likely to be further changes to the tax system when the chancellor announces his pre-budget review, expected in November or early December. The changes this week threw up further anomalies such as the national insurance starting level which will have to be addressed.

· This article was amended on Saturday May 24 2008. Women pensioners under 65 were among the losers when the 10p rate was scrapped because they could not claim working tax credits, not because they could not claim pension credits as we said in the article above. This has been corrected.