(Please note, this is based on my understanding of the current rules and heavy reference to the hmrc.gov.uk website - if I'm wrong please let me know how)
Consider a person working for a private sector company - let's call him/her P. P does work, and the company rewards him/her accordingly. The amount that the government takes depends on how much P earns, so lets look at a few examples.
The tax/NI deducted is largely based on the amount that the company wishes to spend on rewarding P - rather than repeatedly say this, I'll just refer to the amount earnt (although note that because of Employer's NI this will not always be what P would see on his/her payslip as gross earnings).
If P earns less than £5,720 and has no other income, then P would receive the amount in full, with no tax or NI deducted. In fact, if P earnt at least £5,044 then P would be credited with having paid NI (for the purposes of working out the state pension payable) despite not having paid a penny.
Once P's earnings reach £5,721 things get more interesting. All earnings over £5,720 are subject to two lots of deductions. One is Employer's NIC, which is deducted before the money gets near P and at the rate of 12.8%. This means that if P earnt £6,000 the gross pay shown on his/her payslip would be £5,968.23. The second deduction is Employee's NIC, which starts out at 11%, so P would receive £5,940.92. This doesn't sound too bad, but already P has had £59.08 taken from him/her, so the marginal tax rate on that last £280 was 21.1% - more than most people believe the basic rate of tax to be. Bear in mind that this is while earnings are still only £6,000 per year.
If P's gross pay is more than £6,475 (i.e. earnings of £6,571.64 or more) then income tax kicks in at 20%. Suppose P earned £7,000 - this is reduced to £6,854.75 by Employer's NIC, then reduced by another £124.82 by Employee's NI and by £75.95 by Income tax. The marginal rate on the last bit is 38.82%. This is what most basic rate taxpayers actually pay (and you'll note that it's considerably more than the 20% that makes up all the headlines).
The next two changes are quite close together, so I'm going to lump them together. Above gross pay of £43,875 (earnings of £48,758.84) the Income tax rate goes up to 40% and with gross pay above £43,888 (earnings of £48,773.50)the employer's NI rate drops to 1%. Consider then, if P earns £50,000. Employer's NIC drops this to £44,975.32. Then the total employer's NI bill is £4,209.35 and the Income tax bill is £7,920.13. So the company spends £50,000 and P receives only £32,856.71. This is a marginal rate of 46.80%. (incidentally, because the Income tax goes up before the NI goes down, there is a very small crossover period where the marginal rate is 56.64%)
The next interesting part is with gross pay between £100,000 and £112,950 (earnings between £112,067.80 and £126,675.40). For each £2 that your gross pay exceeds £100,000, you lose £1 of the personal allowance, meaning that more of your pay is subject to the 40% tax rate, and less of it is tax free. This has the odd effect of creating a little section where the marginal rate is a lot more than it is above and below.
For example, if P earns £120,000, Employer's NIC drops that to £107,032.06, the P has to pay NI of £4829.92 and income tax of £34,149.24. This has an effective marginal rate of 64.60%. Once P's earnings rise above £126,675.40 the marginal rate drops back down to 46.8%.
The last change is with gross pay above £150,000 (earnings of £168,467.80) where income tax reaches 50%. Consider, if P earns £170,000, Employer's NIC drops that down to £151,358.30. Then the NI is £5,273.18 and the income tax is £53,199.15. The marginal rate is 55.6%
So - to summarise: The basic rate of tax is actually 38.82% rather than the 20% that they tell you, the higher rate is between 46.8% and 64.6% rather than 40%, and the new "50% rate" is actually 55.6%.
And things get even worse next year, when Employer's NI goes up to 13.8%, and Employees goes up to 12% or 2% (although the NI threshold does go up, as does the personal allowance).
Here's a handy table showing marginal tax rates at different earnings levels (numbers may be slightly off - please point out any obvious errors):
Oh - and don't forget that the earnings shown here are before the deduction of Employer's NIC. To work out your earnings based on your salary (assuming it's over £5,720 this year or £6,290 for next year), the formula is:
2010/11: If salary is over £5,720: [ (salary - £5,720) x 1.128 ] + £5,720
2011/12: If salary is over £6,290: [ (salary - £6,290) x 1.138 ] + £6,290
| Earnings | Marginal rate 2010/11 |
| up to £5,720 | 0% |
| £5,721-£6,568 | 21.10% |
| £6,569-£48,590 | 38.83% |
| £48,591-£48,605 | 56.40% |
| £48,606-£111,652 | 46.81% |
| £111,653-£126,203 | 64.54% |
| £126,204-£167,832 | 46.81% |
| £167,833+ | 55.67% |
| Earnings | Marginal rate 2011/12 | ||
| up to £6,290 | 0% | ||
| £6,291-£7,638 | 22.68% | ||
| £7,639-£49,076 | 40.24% | ||
| £49,077-£50,199 | 29.70% | ||
| £50,200-£112,931 | 47.27% | ||
| £112,932-£129,945 | 64.85% | ||
| £129,946-£169,831 | 47.27% | ||
| £169,832+ | 56.07% |
5 comments:
To cut a long story, overall average marginal tax rate is about 50%, and the government spends about £10,000 per year for every man, woman and child in the country.
I was tempted to add in VAT. Considering that we're looking at marginal rates, there's a reasonable chance that the money will be spent on "luxuries" and thus be subject to VAT at the 17.5% rate (20% from 4 January 2011, I believe). That 17.5% rate on the excess takes the "basic rate" taxpayers marginal rate to 47.94% now, and it will be 50.20% next year (taking into account the increases in NI and VAT). That seems rather insane to me...
That's not even allowing for things like alcohol, tobacco and petrol taxes...
Oh - and all the people lauding the "progressive" system, whereby the poor pay only 20% and the rich pay 50% (2 and a half times as much!) How would they feel if they did the sums, and saw that the poor are actually paying near on 50%, and the richest of the rich are paying 62-64% including VAT - it's not quite the divide that they'd like, is it? (although I'd prefer a flat rate and a universal income...)
RA: "I'd prefer a flat rate and a universal income..."
Me too. Even better, 0% income tax or VAT and Land Value Tax. And a universal income.
Quite right to point out these basic points, although there are a few errors.
At the low end, NICs are deducted on the excess over the threshold, like income tax. (This was changed by Gordon Brown in one of his few sensible moves.)
For basic rate taxpayers, then, the marginal rate, taking into account employer's and employee's NICs and income tax, is 12.8 + 11 + 20 = 43.8 percent.
You also really need to factor tax credits into this. They are withdrawn at the rate of 39 percent. If P has kids, his marginal rate, as a BASIC RATE TAXPAYER, can therefore easily be 12.8 + 11 + 20 + 39 = 82.8 percent.
Pretty astonishing, huh?
Hi AC, and thanks for your comment.
As I was looking at the marginal rather than total rate, I may have skipped over a few things a little too quickly, but I think I did take into account both the NI threshold and the Employer's NIC, as follows:
The Lower earning limit for 2010/2011 is £97 per week, and the Threshold is £110 per week. The threshold is thus £5720 per year, and you'll note that I said:
"Once P's earnings reach £5,721 things get more interesting. All earnings over £5,720 are subject to two lots of deductions. One is Employer's NIC... The second deduction is Employee's NIC..."
Further, as the employer's NIC is taken before the money is anywhere near the employee, it doesn't show up on the payslip at all. If I had a gross pay of £100, the total cost to the company would be £112.80, and the deductions applied would be £12.80 Employer's NIC, £11 Employee's NIC and £20 Income tax. This is a total deduction of £43.80 but it's from a total gross amount of £112.80, so the rate is 43.8/112.8 = 38.83% (I had 38.82% in the post above - I was close).
I've not even started looking at the nightmare that is tax credits. Perhaps after some research I might, though...
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