Just how much is tax disincentivising you? The latest Economic and Fiscal Outlook from the Office for Budget Responsibility (OBR) had some disconcerting words to share.
Published alongside the Chancellor’s Spring Forecast in early March, the OBR provided a sober projection of gross domestic product (GDP), warning that high marginal tax rates could increasingly distort incentives to work, save and invest in the UK economy.
What the OBR says about tax and incentives
“The tax-to-GDP ratio is forecast to increase to a post-war high of 38.5 per cent of GDP in 2030/31. And many marginal tax rates – of relevance to incentives to work, save and invest – are much higher. A higher level of the tax take increases the risk that incentives within the tax system distort or constrain economic activity by more than expected.”
As is often the case with the OBR’s words of wisdom, they need some translation:
• The tax-to-GDP ratio
Is a measure of the tax burden on the UK economy. In effect, the government will be taking 38.5p of every £1 the economy generates in four years’ time – the highest rate in modern times.
• Marginal tax rate
Is the effective rate of tax you pay on the extra £1 of income or capital. This can be much higher than the ‘normal’ tax rates and, in extreme situations, can be over 100%.
• Incentives within the tax system distort or constrain economic activity by more than expected.
If you face a high marginal rate of tax, for example, on additional earnings, then you might feel inclined not to accept the promotion that will give you that extra income or choose to work fewer hours at the higher pay rate.
Why £100,000 is a key income threshold
A good example of what the OBR is concerned about can be found at the £100,000 income level. Crossing that threshold means:
• A gradual loss of the personal allowance, equating to a marginal tax rate on earnings of 60% (67.5% in Scotland) up to £125,140 of total income. Add in national insurance (2%) and, for many graduates, student loan repayments (9%), and out of every marginal £1 over £100,000 there could be only 29p (21.5p in Scotland) left to spend.
• Entitlement to tax-free childcare, worth up to £2,000 per child is lost. So too is entitlement (other than in Scotland) worth up to 30 hours of free childcare.
Planning ahead in a high tax environment
The OBR plans to “conduct further analysis of UK marginal tax rates” this year, but given revenue pressures, the chances of reform look slim. Better look to your own tax planning.
RISK WARNING
The value of your investment and any income from it can go down as well as up and you may not get back the full amount you invested.
