Is 60% Income Tax really a thing?

P1Fanatic

I’d never heard of this until a friend mentioned it the other night, that when you start earning over £100k you are starting to lose your tax free allowance (tapered) so are in affect paying 60% tax on earnings between £100-123k (or thereabouts). I read this FT article:

https://www.ft.com/content/622ff86c-d16e-11e5-92a1-c5e23ef99c77

But I can’t get my head around this. All that is happening is that your now paying basic rate tax at 20% on your earnings between £0 and £12,500 that you were previously paying no tax on. You’re not paying 20% + 40% on any of your income. Running the numbers through the MSE Income Tax Calculator gives an average tax rate (Tax Paid / Income) as follows:

£100,00k = £27,496 Tax = 27.5%

£125,018 = £42,507 Tax = 34%

Am I missing something or is the 60% claim just an exaggeration to losing the tax free allowance?

Thanks

Simon

Dazed_and_C0nfused

It is correct.

Are you using the correct figures?

£100k taxable salary and no other taxable income = Personal Allowance of £12,500

£125k taxable salary and no other taxable income = Personal Allowance of £0

For simplicity no relief at source pension contributions or Gift Aid payments.

jim1999

I think possibly what you're missing is that you do not get taxed 40% on earnings over £50,000 - even though that is commonly what is written.

You pay 0% on the first £12,500, then 20% on the next £37,500, and then 40% on the amount above that (exc. 45% rate).

So if your 0% is removed, that £12,500 does not move into the 20% bracket (because that is still on a maximum of £37,500).  Consequently what used to be taxed at 0% is now taxed at 40%.  Because it only reduces your allowance by £1 per £2 of income, however, it is effectively a difference of 40% / 2 = 20%.  Therefore on amounts in this band, you pay your normal 40% tax, plus half of 40% = 60%. 

Clear as mud.

gunge

Strictly you are correct, its introducing charging 20% on the early income and 40% on the above 100k income.  However, the practical effect is that for each pound earned, the individual gets 40p in their pocket and pays HMRC 60p more.  Consequently, for people in the applicable bracket their incentive to earn more is reduced and their incentive to avoid tax  e.g. through pension contributions is greatly increased.
There are other 'losses of benefits' too, which have the effect of increasing the burden on those crossing the 100k boundary - free childcare for children is lost if one parent earns over 100k.  This can be a significant increased burden and the FT had an article a few years back showing that some individuals are better off staying at £99,999 unless their income was going to jump to over £125,000 they would be worse off.
You can debate what the right about of tax for an individual is, but these step changes are stupid, particularly when someone with significantly higher income pays a lower marginal rate.

EdSwippet

Think of it this way. At £100,000 of earnings, your tax is £X, whatever. Now, if you earn another £100, you pay 40% tax on that, so £40. But also, your £12,500 of annual tax free allowance is reduced by £50, meaning that you pay 40% tax on that £50 slice out your allowance. £40 in tax on the £100 income plus £20 in tax on the lost allowance amount comes to £60. So the effective marginal tax rate on earnings between £100k and £125k is 60%. Not exaggeration, then.

In practice, it's often worse, because adding NI of 2% on top of this gets you to 62%. Claiming the tax rate on this band of earnings is 60% is for many people actually an understatement.

Finally, on the numbers you yourself gave from the MSE tax calculator, the difference in tax due between £100k and £125k is £15k. And £15k is 60% of the £25k income difference. Where you're going wrong, I think, is not understanding the difference between average tax rate and marginal tax rate.

P1Fanatic

jim1999 said:

I think possibly what you're missing is that you do not get taxed 40% on earnings over £50,000 - even though that is commonly what is written.

You pay 0% on the first £12,500, then 20% on the next £37,500, and then 40% on the amount above that (exc. 45% rate).

So if your 0% is removed, that £12,500 does not move into the 20% bracket (because that is still on a maximum of £37,500).  Consequently what used to be taxed at 0% is now taxed at 40%.  Because it only reduces your allowance by £1 per £2 of income, however, it is effectively a difference of 40% / 2 = 20%.  Therefore on amounts in this band, you pay your normal 40% tax, plus half of 40% = 60%. 

Clear as mud.

I was indeed struggling with this part as all information I found only shows the tax brackets with the personal allowance in place – not what happens when you lose it. So it’s easy to see why one would assume it’s still 20% tax on the first £50k.

P1Fanatic

EdSwippet said:

Think of it this way. At £100,000 of earnings, your tax is £X, whatever. Now, if you earn another £100, you pay 40% tax on that, so £40. But also, your £12,500 of annual tax free allowance is reduced by £50, meaning that you pay 40% tax on that £50 slice out your allowance. £40 in tax on the £100 income plus £20 in tax on the lost allowance amount comes to £60. So the effective marginal tax rate on earnings between £100k and £125k is 60%. Not exaggeration, then.

In practice, it's often worse, because adding NI of 2% on top of this gets you to 62%. Claiming the tax rate on this band of earnings is 60% is for many people actually an understatement.

Finally, on the numbers you yourself gave from the MSE tax calculator, the difference in tax due between £100k and £125k is £15k. And £15k is 60% of the £25k income difference. Where you're going wrong, I think, is not understanding the difference between average tax rate and marginal tax rate.

Thanks for that explanation - that made it a lot easier to understand. I was aware that average and marginal tax rates are different (maybe I didn't make that clear with my examples of average tax). Just couldnt get my head around how the 60% rate was reached for incomes between 100-125k.

Pennywise

It's real, and for higher earners with decent employer pension schemes, the effect is higher than 62% because they also get hit with penal tax charges on their pension funds (which grow due to employer pension contribution).  Doctors, dentists, etc are particularly badly hit by this as experienced ones tend to earn over £100k and they're usually in the NHS superannuation scheme.  It's a big reason why so many have reduced their working hours.

ffacoffipawb

P1Fanatic said:

I’d never heard of this until a friend mentioned it the other night, that when you start earning over £100k you are starting to lose your tax free allowance (tapered) so are in affect paying 60% tax on earnings between £100-123k (or thereabouts). I read this FT article:

https://www.ft.com/content/622ff86c-d16e-11e5-92a1-c5e23ef99c77

But I can’t get my head around this. All that is happening is that your now paying basic rate tax at 20% on your earnings between £0 and £12,500 that you were previously paying no tax on. You’re not paying 20% + 40% on any of your income. Running the numbers through the MSE Income Tax Calculator gives an average tax rate (Tax Paid / Income) as follows:

£100,00k = £27,496 Tax = 27.5%

£125,018 = £42,507 Tax = 34%

Am I missing something or is the 60% claim just an exaggeration to losing the tax free allowance?

Thanks

Simon

Subtract the second row from the first.

£25,018 earnings and £15,011 tax. The tax is 60% of those earnings. The real tax is 40% at those earnings. The extra 20% is down to the loss of the personal allowance.

csgohan4

Pennywise said:

It's real, and for higher earners with decent employer pension schemes, the effect is higher than 62% because they also get hit with penal tax charges on their pension funds (which grow due to employer pension contribution).  Doctors, dentists, etc are particularly badly hit by this as experienced ones tend to earn over £100k and they're usually in the NHS superannuation scheme.  It's a big reason why so many have reduced their working hours.

Sadly even reducing their sessions or stopping pension contributions may not help, as they run into tapered allowance and still breaching the Annual allowance as their pension still grows

The bottle neck is the AA which used to be higher, but now is a measly 40k. Government basically wants more tax, it's a stealth tax imo, but does come with consequences as Pennywise said as it affects delivery of services with reduction of the workforce providing those sessions


But back to the main topic, either earn below 100k or earn a hell of a lot more over 125k

Pennywise

csgohan4 said:

But back to the main topic, either earn below 100k or earn a hell of a lot more over 125k

Just one of many cliff edges in the tax system.  The same applies with a business like a shop or cafe and the VAT registration threshold of £85k.  Same happens - either reduce opening hours to keep turnover under £85 to avoid VAT registration or open longer to get turnover up to around £100k - in between, you end up worse off than artificially holding the business back under £85k.  It's why lots of fish & chip shops close for a few random weeks and why cafes often close in winter.  They really don't want to have sales of say £90k and end up paying £10k of that in VAT when they could have sales of £84,999 and keep it all!