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Income tax is 63% if you're poor

Posted on | Tags: money, tax, benefits, universal credit, effective marginal tax rate | Comments (5)

For the first time in my life, I'm living on benefits. I've been learning a lot about how the system works, and a few things have surprised me.

Image by Steve Buissinne from Pixabay

I'd heard plenty of horror stories about how unpleasant the process can be, dealing with unsympathetic staff who seem to be looking for excuses to sanction and harass claimants. I was worried about getting hassled to take any job that was available, at the very least. I have to say, that hasn't been my experience at all. In the interest of balancing out the horror stories, I want to say here that the staff I've dealt with at Aberystwyth Job Centre have been polite and helpful, and seem genuinely motivated to support people.

Now, to the point of this article: The effective tax rate. For context, the basic rate of income tax in the UK is 20% and there's a personal allowance - the amount you can earn before any tax is due - of £12,500. If you earn, say, £10,000 per year, the income tax rate is zero.

So what's this about 63%, then? Well, if you're earning little enough to be eligible for Universal Credit* then for every extra pound you earn, your income increases by only 37p because your UC is reduced by 63p. There's not even a personal allowance, at least not if you're a non-disabled person without children; as soon as you earn anything, the benefits are reduced.

This is known as the effective marginal tax rate** and it's the rate that you'd take account of when deciding whether to take paid work or not. This is the way economists traditionally tend to think about things, by the way, as if we're all coolly weighing up whether to make this or that financial decision, rather than just doing whatever we can to make ends meet. More recently, behavioural economics has started to take more account of psychology.

In my case, I'm claiming benefits while working on a project, so I'm pretty busy. Money's tight - should I try to get a bit of extra work to top up my income? If the tourist industry opens up this summer, maybe I could get a bit of part time work? That would be at the minimum wage, which is £8.91 per hour. By the time my UC is docked, I'd effectively be working for £3.30 an hour. Call me proud, but I think my time's worth more than that.

Given the choice between working on my own project and working for someone else (even assuming the work was available), it's just not worth getting the paid work. This is the kind of judgement rich people are expected to make, whenever the prospect of raising the top level tax comes up: "But where's the incentive for them to work if we tax them so heavily?" Somehow that doesn't seem to apply to poor people. I'm lucky that I have a cushion of savings that allow me the luxury of making that decision. If I was entirely dependent on UC, I wouldn't have much choice, I'd have to accept this punitive tax rate.

It's one rule for the rich and another rule for the poor.

* It is very little: under £7,830 per year for a single person over 25 years old. The figures I'm quoting in this article are relevant to myself - the rates for under 25s and the effect of being in a couple are a whole nother article. Return

** or possibly the marginal effective tax rate. I have one version from the Institute of Fiscal Studies and the other from the Financial Times - who to go with? (I went with the FT. This excellent article explains why things are even worse than I've set out here.) Return

Comments (5)

  1. Paul Campbell:
    Mar 09, 2021 at 10:23 PM

    The whole idea of Universal Credit is a complete disaster for the welfare system. It's supposed to help by combining benefits but it just makes the whole amount you get worse so it seems. Luckily I don't claim UC as I'm a carer for my parents so I claim carers allowance which hasn't been combined into UC yet. Yes, the way UC works does make taking low paid part-time work a pay cut. The whole benefits system does need a change and overhauling


    1. rseabrook:
      Mar 10, 2021 at 12:07 AM

      In principle it sounds like a good idea, but in practice it really isn't. I hope your carers allowance remains unaffected.


  2. Clive Nicholas:
    Sep 16, 2021 at 08:08 AM

    And this from a woman who held down what looked like a dream job-for-life as a lecturer in statistics in psychology at Oxford (not that one, the other one). As Rachel knows only too well, university posts don't grow on trees and it can tough getting another one (if you want one). If she can find herself in her present situation, so can anybody (including me, someone with previous experience of tutoring students and currently lumping it on UC with no immediate prospects of any decent work any time soon).


    1. rseabrook:
      Sep 16, 2021 at 08:02 PM

      Hi, Clive. Life can throw up all sorts of surprises, and lots of people who once thought they'd never need to claim benefits can find that they do. I hope your prospects take a turn for the better before long.


  3. Clive Nicholas:
    Sep 17, 2021 at 02:58 AM

    Probably not, but thanks.


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