Top income inequality and tax policy

Abstract

Abstract The share of pre-tax income flowing to the top of the UK income distribution increased continually and substantially in the three decades leading up to the financial crisis, but has changed little since 2013. Using microdata sampled from UK tax records, we describe the nature of top incomes in the UK and how they are taxed. We show that wage income is the dominant source of pre-tax income, even for highest-income 0.1% of UK adults. However, ‘active’ business income—derived from self-employment or closely-held incorporated businesses—is considerably more important for the top 1% than for those with lower incomes. High-income wage earners work disproportionately in financial services. The high-income self-employed are predominately working in partnerships in professions such as accountancy and legal services. Overall, UK income taxes are progressive: average tax rates rise with income. Taxes on top incomes have been increased since 2010, with the result that the post-tax share of income flowing to the top has fallen. But average tax rates vary significantly within the top and depend on how income is received. Incomes from business ownership and investment are taxed at lower rates than employment income. We discuss options for reforming the taxation of top incomes.