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How cuts to marginal income tax could boost the UK’s stagnant economic growth

The British prime minister recently claimed the UK economy has “turned a corner”. Rishi Sunak said inflation figures were encouraging, and proclaimed that 2024 would be the year Britain “bounces back”.

According to his chancellor, Jeremy Hunt, the latest GDP figures show the government’s plan is working. And it’s true that inflation is at its lowest rate for two years, which indicates some easing of the cost-of-living crisis. But prices are still rising, and average incomes have seen limited growth for nearly 20 years.

The broader UK numbers are not very encouraging either. GDP per person has grown by 5.6% since 2007, an annual increase of less than 0.4% a year. In comparison, for the 17 years before 2007, it had grown by 45%, an annual increase of 2.8%.

Growing the economy means more jobs, higher household incomes, and higher standards of living. The clear absence of growth for over a decade has been widely felt.

The median UK household has seen an increase of 9.6% in its disposable (after-tax) income since 2007, which works out at just 0.7% a year. For the lowest earners, this figure is less than 0.2%.

The global financial crisis, Brexit and COVID have all contributed to lower economic growth across most of the world, which results in weak growth in incomes and tax revenues.

So how can incomes for everyone be increased?

Marginal income tax rates

One area worthy of investigation is marginal income tax rates, and the effects they have on the economy. The UK has what’s known as a progressive income tax system, in which the rate you pay is divided into various bands.

When we talk about marginal tax rates, we mean the tax you pay on the next pound you earn. For example, if you earn £51,000, the tax you pay on the next pound earned is £0.40. This means you are paying a marginal tax rate of 40%. It’s different to the average tax paid across your income as a whole. (Rates are different for people living in Scotland.)

But in some circumstances, people whose income level causes them to lose valuable financial benefits, such as child benefit payments or their tax-free personal allowance, can be left facing marginal tax rates way beyond even the highest income tax bracket of 45%.

Research indicates that high marginal income tax rates reduce the financial incentive for people to work more or seek better-paid jobs. People often feel the extra effort or risk is not worth the smaller increase in take-home pay. They would be seeing a cut in their hourly rate, after all.

The higher the marginal tax rate, the stronger the effect. And it doesn’t just affect people moving towards salaries of £50,270 (where the “higher” tax rate of 40% starts) or £125,140 (threshold for the “additional” tax rate of 45%).

In the UK, high marginal income taxes affect even those who receive state benefits. People claiming universal credit see the amount they receive reduce dramatically for every pound they earn beyond their zero-tax personal allowance of £12,570. In some cases, by the time their universal credit payment has been tapered down, people can be hit with a marginal tax rate of over 70% on these earnings.


For the full article co-written by Dr Dawid Trzeciakiewicz visit the Conversation.


Notes for editors

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