Government plans to raise the tax rate for higher earners will fail to raise the £1.6 billion expected and could even lose the Treasury money, a leading think tank warned today.

The calculation from the Insitute of Fiscal Studies (IFS) has emerged only two days before one of the most hotly anticipated Budgets in decades, when the Chancellor is expected to reveal the deteriorating state of the public finances.

Alistair Darling announced plans to increase the rate of income tax for those earning more than £150,000 from 40 per cent to 45 per cent from 2011 in November’s Pre-Budget Report, a move that he said would net the country’s coffers about £1.6 billion.

But the IFS said that the Treasury’s sums were flawed, and that the 350,000 higher earners affected by the move would take action to avoid paying the increased tax rate, costing the Treasury £160 million in lost taxes.

Higher earners were likely to work shorter hours, pay more into their pension or convert income into capital gains, which are taxed at a much lower rate in an effort to minimise their exposure to the higher tax rate, the IFS said.

This, in turn, would also curb their spending, leading to a downturn in consumption taxes such as VAT, the IFS added.

The IFS said that its calculations differed from the Treasury’s as it thought that taxpayers would take more decisive action to avoid paying the tax than the Treasury did.

Even using the Treasury’s own calculations, it said that the money made by the move would fall far short of the Treasury’s estimate, raising only £550 million.

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