NCPA - National Center for Policy Analysis

Tax Reform In Britain

May 24, 1997

Britain's new Labor government is studying ways to reform its tax system to stop discouraging people on welfare from working.

  • The Tories' sharp cuts in the top and basic rates of income tax -- from 83 to 34 percent and 40 to 23 percent, respectively -- and the introduction of a new 20 percent lower rate, have improved work incentives for most of the population by ensuring they get to keep most of any extra money they earn.
  • But those receiving welfare benefits who start to work or increase their earnings reach a point at which they are subject to income taxes while beginning to lose benefits.
  • This produces a "marginal effective tax rate" which is often higher -- and thus a bigger disincentive to working -- than the top income tax rate faced by those much better off.
  • In 1985, 70,000 poorer people faced a marginal effective tax rate of over 100 percent -- that is, every time they earned an extra pound, they would lose more than a pound in extra tax and foregone benefits.

The Tories made changes to this system, so that only 5,000 now facing a rate of 100 percent or more. But the problem is that those facing a 70 percent marginal tax rate have actually increased from 290,000 in 1985 to 645,000 now.

Laborites are considering ways to rectify the situation. One idea under consideration is to adopt an earned income tax credit -- an idea which originated with American Republicans.

In fact, Britain's family credit and America's tax credit are in practice quite similar. The main difference is that the American plan is much more generous. Britain's Labor government would face stiff costs if it were to apply the American alternative.

Source: "Working Poor," Economist, May 24, 1997.


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