The 60% tax trap is stifling economic growth and productivity in the UK, with some of its most valuable workers opting to reduce their earnings rather than increase them. A staggering £25 billion of taxable income remains untapped each year due to this disincentive, which disproportionately affects individuals earning between £100,000 and £125,140. Experts estimate that if these high-earners were to take on more work or invest in productivity enhancements without being deterred by the tax burden, GDP growth could increase by 1.5% annually.
The 60% marginal rate arises from a combination of factors: the 40% higher rate income tax and the gradual withdrawal of the personal allowance once an individual's income exceeds £100,000. For every £2 earned above this threshold, the personal allowance is reduced by £1, resulting in a 60% tax on each additional pound earned between £100,000 and £125,140. Beyond £125,140, the marginal rate reverts to 40% (or 45% for additional rate taxpayers), although the effective tax burden remains significant.
This 'tax trap' creates a substantial disincentive for highly skilled professionals and entrepreneurs to take on more work or invest in further productivity enhancements. In response, some high-earners are reportedly exploring strategies to keep their taxable income below £100,000 threshold or within the band where the personal allowance is not yet fully eroded. This can involve salary sacrifice schemes, increased pension contributions, or even reducing working hours, ultimately limiting the UK's overall economic output.
The implications for UK businesses are substantial: companies relying on highly motivated and productive employees face challenges in driving growth and innovation. If key personnel are actively seeking to limit their earnings due to tax considerations, it can hinder business expansion, investment in new ventures, and the overall competitiveness of the UK economy. A reduction in the incentive to earn more among a productive segment of the workforce could translate into slower GDP growth and reduced tax revenues in the long term.
Addressing this issue could involve several policy considerations, including raising the income threshold at which the personal allowance begins to be withdrawn or reforming its withdrawal to smooth out the effective marginal tax rate. Simplifying the tax system to make it more transparent and removing such unintended penalties is also crucial. Economists warn that failing to tackle this 'tax trap' risks undermining the UK's potential for sustained economic recovery and growth, particularly as the Bank of England continues to navigate inflation targets and interest rate decisions impacting household finances.