7 - Taxes on Income

Abstract

This chapter discusses the taxes on income in the UK. Income tax is levied on earnings and investment incomes of individual persons. In the UK, income tax was introduced as a temporary war measure and did not become a permanent tax until 1860. Income tax complies with the principles of taxation more closely than other taxes. Horizontal equity is provided for by means of personal allowances and vertical equity by progressive rates of income tax. Increase in income tax might create an income effect when people seek to earn more to compensate for higher tax, or substitution effect when they opt for leisure instead of work. Evidence on the disincentive effect of income tax comes from official sources and private research but is inconclusive. The effect of high and progressive rates of income tax is to reduce the ability to save. The willingness to save depends on a variety of factors of which income tax is one. Inflation has distorted the system of income tax, undermined its equity, created a fiscal drag, and led to demands for indexation of tax thresholds and allowances. Negative income tax is a system of taxation that operates on the basis of tax credits that can be used either to off-set tax liability or to be cashed in.