(Please note, this is based on my understanding of the current rules and heavy reference to the hmrc.gov.uk website - if I'm wrong please let me know how)
Consider a person working for a private sector company - let's call him/her P. P does work, and the company rewards him/her accordingly. The amount that the government takes depends on how much P earns, so lets look at a few examples.
The tax/NI deducted is largely based on the amount that the company wishes to spend on rewarding P - rather than repeatedly say this, I'll just refer to the amount earnt (although note that because of Employer's NI this will not always be what P would see on his/her payslip as gross earnings).
If P earns less than £5,720 and has no other income, then P would receive the amount in full, with no tax or NI deducted. In fact, if P earnt at least £5,044 then P would be credited with having paid NI (for the purposes of working out the state pension payable) despite not having paid a penny.
Once P's earnings reach £5,721 things get more interesting. All earnings over £5,720 are subject to two lots of deductions. One is Employer's NIC, which is deducted before the money gets near P and at the rate of 12.8%. This means that if P earnt £6,000 the gross pay shown on his/her payslip would be £5,968.23. The second deduction is Employee's NIC, which starts out at 11%, so P would receive £5,940.92. This doesn't sound too bad, but already P has had £59.08 taken from him/her, so the marginal tax rate on that last £280 was 21.1% - more than most people believe the basic rate of tax to be. Bear in mind that this is while earnings are still only £6,000 per year.
If P's gross pay is more than £6,475 (i.e. earnings of £6,571.64 or more) then income tax kicks in at 20%. Suppose P earned £7,000 - this is reduced to £6,854.75 by Employer's NIC, then reduced by another £124.82 by Employee's NI and by £75.95 by Income tax. The marginal rate on the last bit is 38.82%. This is what most basic rate taxpayers actually pay (and you'll note that it's considerably more than the 20% that makes up all the headlines).
The next two changes are quite close together, so I'm going to lump them together. Above gross pay of £43,875 (earnings of £48,758.84) the Income tax rate goes up to 40% and with gross pay above £43,888 (earnings of £48,773.50)the employer's NI rate drops to 1%. Consider then, if P earns £50,000. Employer's NIC drops this to £44,975.32. Then the total employer's NI bill is £4,209.35 and the Income tax bill is £7,920.13. So the company spends £50,000 and P receives only £32,856.71. This is a marginal rate of 46.80%. (incidentally, because the Income tax goes up before the NI goes down, there is a very small crossover period where the marginal rate is 56.64%)
The next interesting part is with gross pay between £100,000 and £112,950 (earnings between £112,067.80 and £126,675.40). For each £2 that your gross pay exceeds £100,000, you lose £1 of the personal allowance, meaning that more of your pay is subject to the 40% tax rate, and less of it is tax free. This has the odd effect of creating a little section where the marginal rate is a lot more than it is above and below.
For example, if P earns £120,000, Employer's NIC drops that to £107,032.06, the P has to pay NI of £4829.92 and income tax of £34,149.24. This has an effective marginal rate of 64.60%. Once P's earnings rise above £126,675.40 the marginal rate drops back down to 46.8%.
The last change is with gross pay above £150,000 (earnings of £168,467.80) where income tax reaches 50%. Consider, if P earns £170,000, Employer's NIC drops that down to £151,358.30. Then the NI is £5,273.18 and the income tax is £53,199.15. The marginal rate is 55.6%
So - to summarise: The basic rate of tax is actually 38.82% rather than the 20% that they tell you, the higher rate is between 46.8% and 64.6% rather than 40%, and the new "50% rate" is actually 55.6%.
And things get even worse next year, when Employer's NI goes up to 13.8%, and Employees goes up to 12% or 2% (although the NI threshold does go up, as does the personal allowance).
Here's a handy table showing marginal tax rates at different earnings levels (numbers may be slightly off - please point out any obvious errors):
Oh - and don't forget that the earnings shown here are before the deduction of Employer's NIC. To work out your earnings based on your salary (assuming it's over £5,720 this year or £6,290 for next year), the formula is:
2010/11: If salary is over £5,720: [ (salary - £5,720) x 1.128 ] + £5,720
2011/12: If salary is over £6,290: [ (salary - £6,290) x 1.138 ] + £6,290
|Earnings||Marginal rate 2010/11|
|up to £5,720||0%|
|Earnings||Marginal rate 2011/12|
|up to £6,290||0%|