Different income tax brackets are used to ensure that higher income earners make a fair contribution to society. However, higher tax rates reduce the amount of tax that is collected because they take away the incentive to work harder. This article describes the reasons for different income tax brackets.
Advantages of progressive tax rates
Many systems of taxation apply different tax rates to different levels of income. The rates normally increase as the level of income increases. Such a system is referred to as a progressive tax system. Those with higher incomes pay a higher rate of tax on the top part of their income that is above a certain threshold. For 01.12.11, the UK tax laws impose a rate of 20% on taxable incomes of up to £35000, a rate of 40% on incomes between £35001 and £150000 and a 50% rate on incomes above £150000. Taxable income is computed after deducting a personal allowance of £7475 for tax year 01.12.11 for taxpayers who are aged under 65 and higher allowances for older taxpayers. The reasons normally given for structuring income taxes in this way is that those who earn more income should contribute more to society. It is argued that even after contributing at higher rates, the high earners still take home relatively more income than other taxpayers. A progressive tax system reduces the difference between after-tax incomes. It enforces the principle that those who receive higher incomes have a duty to give back some of their income to the state which has created the conditions for them to earn their income. A progressive tax system allows the government to impose low tax rates for lower earners. The latter group needs to retain a higher proportion of their income to spend on necessities. This compensates them for the effects of the prices of customs duties and indirect taxes. These are normally much less progressive and therefore, impose a relatively high burden on the lowest income groups.
Disadvantages of progressive tax rates
In theory, a higher tax rate which is imposed on top earners, increases the total tax received by the state. There is, however, a counterargument to the effect that imposing higher rates of tax acts as a disincentive to work. It can therefore decrease the collected taxes. A system with higher tax brackets is often seen as inefficient because higher administrative costs are required to operate the system. People with higher incomes are hence, given an incentive to evade tax. A progressive tax system may encourage those who earn higher incomes to move to a country where the tax rates are lower. This will result in a brain drain that reduces the economic growth in the long run.