Too embarrassed to ask: what is a marginal tax rate?
Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. Here's how that works.
Tax comes in many different forms – VAT, capital gains tax, inheritance tax, income tax – and different people pay it at different rates. Typically, the more you earn, the more tax you pay; this is what’s known as a “progressive” tax system.
Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. For example, take income tax rates in the UK. As of the tax year that started in April 2021, there is no income tax due on any money you earn up to £12,570. Then, for every pound you earn above that, you will pay 20%. This is your marginal tax rate.
Then once you earn more than £50,270, your marginal income tax rate goes up to 40%. Once you earn over £150,000, it goes up again, to 45%, so for every pound you earn, you keep 55p and 45p goes to the tax office.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
So far, so straightforward – as you earn more, you pay more tax.
However, years of government tinkering designed to raise more money without upsetting too many voters has left us with a very complicated tax and benefits system. As a result, different taxes kick in at different income levels, while certain benefits are clawed back. These interactions sometimes create huge spikes in marginal tax rates for certain groups.
For example, child benefit is clawed back once one person in a household starts earning above £50,000 a year. This could result in a marginal tax rate of more than 58% on earnings above £50,000 – or even more in the case of families with more than one child.
Similarly, once someone earns more than £100,000 a year, their personal allowance – the amount on which they pay 0% income tax – starts to be clawed back. This creates a marginal tax rate of 60%.
Taxing marginal income at these levels seems counterproductive. However, a cleaner, more transparent tax system might make it clear just how much we have to pay. And governments tend to lack the political nerve to embrace that sort of transparency.
To learn more about tax and tax efficiency, subscribe to MoneyWeek magazine.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
-
Nationwide hikes FlexPlus current account fee by £5 a month – is it worth it?
Nationwide’s FlexPlus current account is a favourite with customers, but it’s worth checking whether you are taking advantage of the perks after the monthly fee went from £13 to £18
By Katie Williams Published
-
Santander launches online pension that offers up to £1,000 cashback
Santander's self-invested personal pension offers customers cashback of up to £1,000 if they invest before 25 April next year - here is everything you need to know
By Chris Newlands Published
-
What is a dividend yield?
Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
By Rupert Hargreaves Published
-
High earners to pay nearly £2000 more in tax due to fiscal drag
Videos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
By Nicole García Mérida Last updated
-
What is a deficit?
Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
By MoneyWeek Published
-
Too embarrassed to ask: what is moral hazard?
Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
By MoneyWeek Published
-
Too embarrassed to ask: what is contagion?
Videos Most of us probably know what “contagion” is in a biological sense. But it also crops up in financial markets. Here's what it means.
By MoneyWeek Published
-
Too embarrassed to ask: what is stagflation?
Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
By MoneyWeek Published
-
Too embarrassed to ask: what is the metaverse?
Videos The term “metaverse” sounds like something out of a science fiction novel (and it is). But what does it actually mean?
By MoneyWeek Published
-
Too embarrassed to ask: what is the gold standard?
Videos These days, most currencies are "fiat" currencies backed by the economies of the countries that issue them. But in days gone by currencies were on the "gold standard". Here's what that means.
By MoneyWeek Published