An anomaly in the UK's income tax system, known as the 60% tax trap, is increasingly affecting millions of individuals, sparking debate about its impact on the economy and fairness. This unintended consequence arises when individuals earning between £100,000 and £125,140 face a marginal tax rate of 60% on additional income, significantly higher than the stated top rate of 45%.
The issue stems from the gradual withdrawal of the personal allowance for those earning above £100,000. For every £2 earned above this threshold, an individual loses £1 of their tax-free allowance. This effectively increases the higher rate of income tax from 40% to 60% within this income bracket. Once an individual's income reaches £125,140, their entire personal allowance is lost, and they then move to the 45% additional rate.
This tax contrivance, introduced in 2010 by then Chancellor Alistair Darling, was initially a niche concern. However, the £100,000 threshold has remained frozen for over a decade, unaffected by inflation. Had the threshold been adjusted for inflation since its introduction, it would now stand at approximately £181,000. Consequently, the number of people caught in the 60% trap has surged.
HMRC estimates indicate that in the 2024-2025 tax year, nearly 1.5 million people paid the effective 60% tax rate. This figure includes 591,000 individuals losing part of their personal allowance and 885,000 who have lost it entirely. This means that for every £100 earned within this bracket, £60 goes to income tax.
The 'trap' has led to two primary outcomes: a sense of unfairness among affected individuals and attempts to mitigate its impact. Many high earners seek to reduce their taxable income through methods such as increased pension contributions, salary sacrifice schemes for benefits like bikes or electric cars, or by accepting a reduction in working hours or turning down additional work to stay below the £100,000 threshold.
This issue is further complicated by the fact that childcare support can be withdrawn if one partner earns over £100,000, potentially creating an even higher marginal tax rate. Critics argue that this system is counterproductive for an economy reliant on the tax contributions of high earners, who contribute a substantial portion of overall income tax receipts.
Several potential solutions have been proposed to address the 60% tax trap. One suggestion is to abolish the personal allowance taper entirely, ensuring everyone retains their tax-free allowance. This would eliminate the trap but comes with a fiscal cost. Another option is to widen the taper band, extending the income range over which the allowance is withdrawn, thereby reducing the marginal rate.
A more transparent approach could involve introducing a clear, additional tax band or surcharge for higher earners, rather than relying on the stealthy withdrawal of allowances. Ultimately, some propose a broader reform of the UK's tax system to simplify transitions between tax bands and remove hidden cliffs that can penalize individuals.
Despite calls for reform, successive governments have been hesitant to address the issue, partly due to concerns about appearing to favor higher earners or offering tax breaks. However, proponents of reform argue that fixing this damaging anomaly is essential for economic growth and that the justification for such a change would be strong, potentially garnering broader public support than anticipated.