Readers Question: How do progressive taxes reduce inequality?

Readers Question: If a progressive taxation is going to supposedly “reduce the gap between the rich and poor”, how and why does this happen?

A progressive tax means that we take a higher % of tax from those on high incomes (e.g. a 50% income tax rate for income above £150,000).

If everyone paid a flat rate of income tax of 20%, this would be a proportional tax. Everyone pays the same % of income in tax.

The UK income tax is progressive. For example, in 2011-12, the income tax threshold is £7,475.

  • This means if your annual income is £7,475, you pay zero income tax.
  • If you earn £8,474. Then you pay 20% on the £1,000 above the income tax threshold. (£200 in tax)
  • Therefore, your average tax rate is only 2%.

However, for those earning over £150,000 there is currently a top rate of income tax – 50%. Income over £150,000 is taxed at 50%. Therefore, someone earning £200,000 will be paying substantially more tax than a low income earner. Their average tax rate will be much higher. (see: impact of 50% income tax rate)

If this top rate was increased to 60%, we could say the tax system is becoming even more progressive. This would reduce the post-tax income for those earning high salaries. It would help reduce the gap between high and low paid, by reducing disposable income of high income earners.

Benefits

Progressive tax takes a higher % of income from high earners bringing their incomes down – closer to those on low incomes. However the tax raised from progressive income tax can be used to boost the disposable income of low paid and the unemployment.

For example, the government can pay more income support (diret gov). This is a means tested benefit to those on low incomes. It increases their income closer to the average.

Regressive taxes

The UK income tax system is quite progressive. Those on high incomes pay substantially more than those on low incomes. This helps reduce the gap between rich and poor. However, in addition to income tax we also have many regressive taxes – e.g. VAT, excise duty (tobacco, alcohol) e.t.c

Tobacco tax takes a higher % of income in tax from low income workers. If you smoke one packet a day, the total tax will be the same. But, for someone on £10,000 a year, it will be a much bigger % of their income.

Therefore, reducing regressive taxes and increasing progressive taxes is another way to reduce post-tax income inequality. However, as progressive taxes are increased, there is a disincentive to work and the willingness to work will decline.

Also regressive taxes (alcohol, petrol and tobacco) have a role in making consumers pay for the social costs of consumption.

Related

Item added to cart.
0 items - £0.00