As taxable income
rises so does the marginal tax rate- to a maximum of 40 per cent. Thus, income tax
is progressive: the higher the income, the larger the proportion of it which is paid in tax. Or we can
say that as taxable income decreases, the marginal tax rate goes down. Think about this for the entire economy. Initially, personal income taxes may yield
the government, say, £50 billion per year. Now suppose that, for whatever reason
, business activity suddenly starts to slow down. When this happens, worker
s are not allowed to put in as much overtime as before. Some workers are laid off, and some must change to job
s that pay less.
What happens to taxes when wages and salaries go down? Taxes are still paid but at a lower rate than before, since tax-rates are progressive. Some people who had been paying marginal rates of 40 per cent will now pay only the standard rate of 29 per cent. As a result of these decreased taxes, disposable income- the amount remaining after taxes- does not fall by the same percentage as before-tax income. The individual, in other words, does not feel the pinch of recession as much as we might think if we ignored the progressive nature of our tax schedule. The average tax-rate falls when less is earned.
Conversely, when the economy suddenly comes into a boom period, people's incomes tend to rise. They can work more overtime and can change to higher-paying jobs. However, their disposable income does not go up as rapidly as their total income, because their average tax rates are rising at the same time. The government takes a larger proportion of income in tax, as incomes rise. In this way, the progressive income tax system tends to stabilize any abrupt changes in economic activity. Tax revenue rises as the economy booms, and falls as activity diminishes. (N.B. The figures in this node relate to the UK only)