More than half a million people are paying a marginal tax rate of 60 per cent on the next pound they earn.
More people than ever are being stung by the 60 per cent tax trap, which affects those earning between £100,000 and £125,150 a year, according to Bowmore Financial Planning.
While the official top income tax rate is 45 per cent for earnings above £125,140, the removal of the personal allowance above £100,000 means an even higher marginal rate just below that.
This is because for every extra £1 earned between £100,000 and £125,150, 50p of the tax-free personal allowance is removed, turning the 40 per cent higher income tax rate into 60 per cent.
The number of people paying a marginal tax rate of over 60% is now half a million. Data source: Bowmore Financial Planning
While there are other instances where removing benefits interacts with earnings, such as the child benefit tax trap, the 60 per cent rate caused by the removal of the personal allowance is one that is baked into the income tax system.
It creates a sky-high marginal tax rate, the term for the rate paid on the next pound earned.
It means that income tax rates start at 20 per cent, rise to 40 per cent, then hit 60 per cent between £100,000 and £125,150, before dropping back to 45 per cent above that.
This means that while someone earning £100,000 would lose 60 per cent of a £5,000 pay rise to tax, someone earning £200,000 would only lose 45 per cent.
Tax traps: The chart above shows marginal tax rates for income tax and national insurance which rise to 62% for those earning between £100,000 and £125,150
The number of taxpayers paying this higher rate has increased 23 per cent in the past year, from 436,000 to 537,000, according to Bowmore, as inflation pushes wages higher.
It has called on the Government to take ‘urgent action to fix this inequality in the income tax system’.
Meanwhile, the number of taxpayers whose earnings have risen through the 60 per cent tax trap and have gone on to pay the 45p additional rate of tax has also risen dramatically.
Official figures show additional rate payers increased from 950,000 to 1.13million in the past year.
This nearly doubled the 587,000 who paid the highest rate in 2022/23, after former Chancellor Jeremy Hunt lowered the 45p tax threshold from £150,000 to £125,140.
Higher income tax rates in Scotland make the situation worse north of the border, as the advanced rate of tax there of 45 per cent applies above £75,000.
The tax raid from frozen thresholds
It is not just those earning between £100,000 and £125,150 that are being hit with higher taxes. The freeze on income tax thresholds combined with high inflation has created a huge tax raid.
Keeping the basic rate threshold at £12,570 drags more of people’s income into 20 per cent tax.
At the same time, the £50,270 higher rate threshold has not changed since April 2021, while the additional rate threshold was cut to £125,140
The £100,000 threshold at which the personal allowance starts to be removed has not moved since its introduction 15 years ago. If it had risen in line with inflation, it would be £153,000.
HMRC figures show that 6.3million people are paying 40 per cent tax this year, up from 6million this year, and nearly double the number that paid the higher rate of tax in 2010.
The Institute for Fiscal Studies expects 8.7million people to pay the higher or additional rates by 2028/29.
Mark Incledon, chief executive at Bowmore Financial Planning said: ‘Reaching a six-figure salary has long been a major goal for a lot of people.
‘We all understand that this comes with the obligation to pay more tax. Unfortunately, if HMRC takes 60p in every pound you earn above £100,000, the lure of getting there is a lot more limited.
If HMRC takes 60p in every pound you earn above £100,000, the lure of getting there is a lot more limited
‘With the increased cost of living eroding the real value of salary increases, the incoming government must address the tax trap for higher earners.
‘It only disincentivises people from working harder, being more productive and ultimately generating economic growth.’
It’s not just higher earners being stung, pensioners are also being caught out by frozen thresholds.
The number of people over state pension age paying income tax rose by 660,000 to 8.51million.
It means there are now nearly 9million of those aged 65 or over paying tax on their income, compared with 4.9million in 2010/11.
While the state pension triple lock ensures it rises in line with inflation, earnings or 2.5 per cent, retaining the freeze on the personal allowance means that a pensioner who receives the £11,500 a year full state pension and some private pension income is liable to pay income tax.
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