Over half a million workers in the UK are now caught in a tax system that forces them to pay as much as 60% of their salary above £100,000, triggering fears that this “tax trap” could demotivate high earners and harm economic growth. This taxation anomaly has sparked alarm, as many are finding themselves penalised for earning above a seemingly modest threshold.
The issue stems from a peculiar aspect of the UK’s tax system: individuals earning between £100,000 and £125,140 face a drastic reduction in their personal allowance, which leads to significant portions of their salary being taxed at a higher rate. With over 500,000 taxpayers affected, experts are now calling for urgent reform to address the issue.
A Hard Hit for High Earners: The Flaws in the Tax System
For those in this salary band, earning a modest increase can lead to a severe jump in the amount of tax paid.
As an example, Victoria, a taxpayer earning £125,000 annually, finds her personal allowance reduced from £12,570 to just £70. This leaves her with an effective income tax rate of 60% on any income above £100,000. In total, Victoria would pay £42,432 in income tax alone.
However, experts have pointed out that making pension contributions is one way to alleviate the burden. By contributing to a pension, an individual can reduce their income for tax purposes, thereby avoiding the 60% rate.
According to Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, such a strategy not only helps reduce immediate tax liabilities but also boosts long-term retirement savings.
For instance, by contributing £25,000 to a pension, Victoria could reduce her taxable income to £100,000, restoring her personal allowance and lowering her tax bill by £15,000.
Experts Call for Reform
The current tax system, which imposes such a punitive rate, has raised concerns about its effects on productivity. Mark Incledon, chief executive at Bowmore Financial Planning, emphasised that this steep tax trap discourages people from working harder or striving for higher wages.
With 60% of every additional pound earned above £100,000 going to taxes, many workers may feel disincentivised to push for higher earnings or take on additional hours.
The Treasury, however, has responded by stressing that it is committed to keeping taxes low while ensuring fiscal responsibility. A spokesman for the Treasury reiterated that there are no plans to raise income tax, National Insurance, or VAT, with an emphasis on stimulating investment and economic growth.
Yet, despite the Government’s claims, critics argue that the 60% tax trap could be undermining its stated goals of fostering economic growth and improving living standards.
