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.   

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.

Recommended

Digital pound likely to launch this decade
Currencies

Digital pound likely to launch this decade

The Treasury and the Bank of England have launched a consultation on the introduction of a state-backed digital pound. We explain how a “Britcoin” cou…
7 Feb 2023
Treasury grills bank bosses over savings rates
Savings

Treasury grills bank bosses over savings rates

The Treasury Select Committee says customers are earning between 0.5% and 0.65% on basic savings accounts, well below the Bank of England base rate
7 Feb 2023
NS&I raises rates on its Green Savings Bonds
Savings

NS&I raises rates on its Green Savings Bonds

NS&I has boosted the rate on its Green Savings Bonds as it plays catch up to the savings market
7 Feb 2023
The best offers for switching banks – get up to £200 free cash
Personal finance

The best offers for switching banks – get up to £200 free cash

Looking to move bank accounts? You can now bag as much as £200 for switching current accounts.
7 Feb 2023

Most Popular

NS&I brings back one-year fixed bonds with highest rates since 2010
Personal finance

NS&I brings back one-year fixed bonds with highest rates since 2010

NS&I’s one-year fixed bonds are back on sale after being pulled off the market in 2019 - but is the rate any good?
1 Feb 2023
The best one-year fixed savings accounts - February 2023
Savings

The best one-year fixed savings accounts - February 2023

Earn almost 5% on one-year fixed savings accounts.
6 Feb 2023
Will energy prices go down in 2023?
Personal finance

Will energy prices go down in 2023?

Wholesale gas prices are on a downward trajectory, but does this mean lower energy bills later this year?
6 Feb 2023