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Monday, June 09, 2014

UK income tax bands

Presenting His Royal Highness King Milo the First! by Malingering from flickr (CC-NC-ND)
You'd think that a question like - what are the income tax bands and rates in UK - would have an extremely straightforward answer you can check on government websites or Wikipedia. And you'd be wrong.

Between income tax, National Insurance (second income tax), and personal allowance phaseout the rates are nothing like what they seem at first (20%, 40%, 45% - yeah right).

Here are the rates I calculated:
  • £0-£7955 - 0%
  • £7955-£10,000 - 12%
  • £10,000-£41,860 - 32%
  • £41,860-£41,865 - 22% (yes, it's a £5 wide tax band)
  • £41,865-£100,000 - 42%
  • £100,000-£120,000 - 62%
  • £120,000-£150,000 - 42%
  • £150,000+ - 47%
In other words - WTF?

The tiny 22% tax band is an artifact caused by the primary income tax being calculated based on annual income, and the second income tax based on weekly income. Assuming 52 work weeks a year, their bands are just slightly misaligned, but if you work fewer weeks a year, this band can widen and you could be paying a lot less in taxes. I'm not entirely sure how that works in practice.

Conversely, 12% band is due to much larger misalignment between two income taxes, and it could widen a lot if you have high weekly wages, but work less than full year, so you'd end up paying no income tax, but lot of NI.

Even weirder case is the 62% band. It's regular 40% rate + 2% NI rate + 50% reduction of personal income allowance which gets retaxed from 0% rate into 40% rate, which is de facto third income tax of 20% applicable only for income between £100k and £120k.

Now, there are many legitimate arguments against income taxes in general, including:
  • high income taxes (especially that 62% rate) generate serious disincentive to work
  • taxing annual income means self-employed people whose income changes from year to year end up paying a lot more than people with stable income
  • taxing income instead of wealth means rich people can technically have low "incomes" and pay very little, while people with just salary and no wealth whatsoever and paying a ton
  • tax bands make no adjustment for cost of living depending on region - so a person living in London will end up in higher tax band at standards of living much lower than a person living in the middle of nowhere - resulting in another way how London subsidises the rest of UK
  • bankers making millions are probably all paying much lower rates than the middle class since they can hire some tax avoidance lawyers and there are convenient tax shelters located just next to the UK.
But even ignoring all that, why the hell can't we just fold three taxes all into a single tax, with monotonic bands?

In all these calculations I'm ignoring 4th income tax - employer's NI contribution, as it's technically not part of gross wages, even though economically it doesn't matter what numbers are printed on the payslip, only how much employer pays before taxes, and how much employee receives after taxes.

And a bonus question for behavioural economics exam: Would marginal income tax rates be more or less disincentivizing if people have no idea how much tax they're paying because taxes are so damn complicated?

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