This is from a loyal reader named “a”:
How high are marginal rates of deductions in the UK?:
Consider an employee paid £50,000 gross who gets a £1,000 pay rise.
Let’s assume they are yet to pay off their student loan and contribute 7.5% to a (underfunded*) pension scheme and get 8% employer contributions to their pension.
Our employee’s employer will also pay the government an extra £218 pension contributions and national insurance (payroll) contributions, 8% and 13.8% of gross earnings respectively.
So the total increase in cost to the employer is £1,218.
Of their pay rise our employee pays £75 pension contributions, £90 student loan repayments, and £370 in income tax, giving total employee deductions £555.
This gives a marginal deduction rate of 63.46% (£445/£1,218).
If our employee buys goods which are liable for VAT they will lose a further 20%, resulting in a 70.77% marginal rate of deductions.
Oh and our employee must pay a local government lump sum tax of around £1,500 from their net wages.
So our employee faces a marginal rate of deductions 63.46% on non-VAT items, 70.77% on VAT items, and an average rate of deduction of 52% of pre-deduction earnings.
A similar analysis on a worker paid the minimum wage (around £12,500 a year), or £1000 above the minimum wage results in a marginal rate of deduction of 32% and an average rate of deduction of 52%. This ignores the withdrawal of means tested benefits.
Might this be the supply side explanation Scott Sumner has been looking for?
* UK private pension schemes currently have a £265bn deficit.