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UK Taxes

UK Taxes

Did you know that taxes are not collected nor calculated the same way across the globe? Countries often have different methods for collecting taxes from their citizens to be optimal for the needs of their society. If you are familiar with the tax system in the United States, then you will recognize some features of the tax system in the United Kingdom, while others might be different. If you're looking to gain a better understanding of how taxes in the UK work and how they may differ between the US and the UK, you've come to the right place! Let's jump right in!

UK Taxes Explained

How are UK taxes explained? Well, a tax is a fee charged by and paid to a nation's government by its citizens and residents. The United Kingdom is one of the world's most highly taxed populations. The total income collected from taxes and other sources by the government for the 2021/22 tax year is around £915 billion, which is 39% of the UK's GDP.1 Of this, £530 billion came from income tax, National Income Contributions (NIC), and Value Added Tax (VAT), which are the three largest sources of income for the UK government.1 The UK's tax year spans from April 6th to April 5th the following year.

The tax rate in the UK is set and collected by His Majesty's Revenue and Customs (HMRC). This organization is the authority responsible for calculating the tax rate and collecting taxes. HMRC is also responsible for providing funds for UK public services such as child benefits, housing benefits, and income support.2

A tax is a fee charged by and paid to a nation's government by its citizens and residents.

His Majesty's Revenue and Customs is the United Kingdom's tax authority, responsible for collecting taxes and providing funds for public services.

What is the United Kingdom?

What is the UK? Is it a country? A union? Then what is England or Scotland? The UK is made up of four countries: England, Scotland, Wales, and Northern Ireland. The first three nations are located on the island of Great Britain and Northern Ireland is located on the island of Ireland, not to be confused with the Republic of Ireland which makes up the rest of Ireland and is not part of the UK.

Therefore, the UK is considered an independent sovereign state. The countries that form it each have their own individual identities, rights, and laws, but they make decisions together similar to the European Union.

The UK has a Pay As You Earn (PAYE) system that collects income tax and National Insurance tax directly from an employee's monthly paycheck. This helps taxpayers avoid a large bill at the end of the tax year and ensures they contribute to the national pension. Businesses and self-employed people, much like in the United States, can pay their taxes every three months to remain up to date.

Other taxes, such as value-added tax (VAT), which is equivalent to sales tax in the United States, and excise duties, are collected or paid when goods and services are purchased, sold, or produced.

The UK uses taxes both for generating an income for their government and as a means of regulation. Taxes on products like alcohol and tobacco, known colloquially as sin taxes, or fossil fuels can serve to discourage consumers from overindulging in those types of products. Taxes on pollutants like fossil fuels can serve to reduce emissions and protect the environment while also benefiting the government and its citizens.

List of UK Taxes

The list of UK taxes is longer than just the income tax and NI tax. HMRC also employs other forms of taxes to generate income for the government. They decide the tax rate for things such as corporations, capital gains, inheritance, etc. Let's take a look at some of the taxes HMRC is responsible for.

  • Income tax
  • Value-Added Tax (VAT)
  • National Insurance Contributions (NIC)
  • Excise Duties
  • Tobacco and Alcohol Tax (Sin Tax)
  • Corporation Tax
  • Capital Tax
  • Inheritance Tax
  • Insurance Premium Tax
  • Stamp, Land, and Petroleum Revenue Taxes (Fuel Duty)
  • Environmental Taxes
  • Climate Change and Aggregates Levy and Landfill Tax
  • Customs Duty

Beyond taxes, the parliament also earns an income from what is called Receipts. These receipts are other forms of cash inflows for the government such as money earned from investments, loan repayments, or sales.

UK Taxes UK public sector receipts and taxes for 2021/22 StudySmarter
Fig 1. - UK Public Sector Receipts and Taxes for 2021/22. Source: UK Parliament, House of Commons Library

The taxes and other sources of cash inflow such as interest payments for the UK government in Figure 1 come out to a total of £916 billion in the 2021/22 tax year, which is around 39% of the UK's GDP.5 Of that £916 billion, the three main sections earned £530 billion of the tax revenue.5

3 Main Taxes in The UK

While there are many different forms of tax in the UK, the 3 main taxes in the UK that bring in the most funds are income tax, National Insurance Contributions, and value-added tax. The income tax is the tax that taxpayers pay on their wages, or on their earnings if they are self-employed. The NIC is a tax that is also deducted from a worker's wages and it goes toward paying state pensions and benefits for those who qualify. Value-added tax is the tax paid on items that are purchased. It is equivalent to the United States' sales tax.

UK Taxes: Income Tax

The UK uses a progressive tax system. This means that you pay a higher tax rate the more income you make. The first £12,570 earned is labeled as a personal allowance and is not taxed. Any income from £12,571 to £50,270 is taxed at 20%, and the next portion is taxed at a higher rate, and so on. As you earn more income the tax rate becomes progressively higher. If your income exceeds £150,000, you do not qualify for a personal allowance.

A Progressive Tax System is a tax system where, as the taxpayer's income increases, their average tax rate increases.

BandTaxable IncomeTax Rate
Personal Allowance£0 to £12,5700%
Basic Rate£12,571 to £50,27020%
High Rate£50,271 to £150,00040%
Additional Rate£150,001 and above45%
Table 1. Progressive tax rates in the United Kingdom for the tax year 2022-23. Source: Gov.uk

John earns a total of £80,000 per year. April 5th is approaching and John wants to calculate how much he paid in income taxes this year. John knows he qualifies for the personal allowance so his taxable income is £67,430.

\( 80,000-12,570=67,430 \)

Now, John must pay taxes on the taxable portion. John earns over £50,270 of taxable income, meaning he has to pay the basic rate of 20% on the first £37,699 and the high rate on the remaining £29,730.

\( 50,270-12,571=37,699 \)

\( 37,699 \times 0.2=7,539.8 \)

Next, John must calculate the amount he owes at the high tax rate.

\( 80,000-50,271=29,729 \)

\( 29,729 \times 0.4=11,891.6 \)

To figure out the total income tax John will pay, he must add together the amount of tax owed at the basic rate and the high rate.

\( 7,539.8+11,891.6=19,431.4 \)

John will pay £19,431.40 in income taxes this year.

UK Taxes: National Insurance Contributions

For National Insurance (NI), the UK uses the same PAYE system for its NIC as with its income tax. NIC is a government-mandated contribution or tax that citizens must pay toward the UK's state pensions and benefits. The NIC is set up similarly to the income tax where there are three income brackets that determine how much NIC you must pay monthly. NIC is calculated the same way as income tax, where the first £241 are not taxed, the money from £242 to £967 is taxed at 13.25%, and the remainder is taxed at 3.25%.

Weekly IncomeClass 1 National Insurance Rate
£0 to £2410%
£242 to £96713.25%
Over £9673.25%

Table 2. The tax rate for UK National Insurance for 2022-23.

Source: Gov.uk

Table 2 shows the tax rate if you qualify for Class 1, which is for employed people earning more than £242 per week. The employer also has to pay a portion of the benefits or expenses. Then there are Classes 2, 3, & 4, which collect payments from people who are self-employed earning at least £6,725 annually, voluntarily contributing, or self-employed people who earn more than £11,909 annually, respectively.

Keep in mind that depending on age and circumstances such as disability or maternity, there are exemptions and exceptions for certain taxpayers.

UK Taxes: Value Added Tax

When you walk into a shop in the UK to purchase an item, value-added tax, or VAT, has already been added to the sticker price. When you walk up to the cashier to pay for your item you pay the price you saw on the label. As of 2022, the VAT for most goods and services that taxpayers purchase is 20%.6

VAT Rate% of VATWhat it applies to
Standard Rate20%Majority of goods and services.
Reduced Rate 5%Some goods and services like child car seats or home energy like heating.
Zero Rate0%Some goods and services like children's clothing and most food.
Table 3. - VAT rates and what they apply to. Source: Gov.uk

Table 3 shows the three different VAT amounts that can be set on purchases. Goods that are deemed essential like food and clothing for children are exempt from these taxes in an effort to keep prices as affordable as possible.6 Other services that are still necessary but not as essential or more broadly affect the population, like heating, are subject to the reduced rate.6

On the other hand, businesses are required to register for and add VAT to their prices when they bring in more than £85,000 in turnover on items that qualify including zero-rate goods.7 A business then must report to HMRC how much they charged their customers in VAT and how much they paid in VAT to other businesses such as suppliers.7

UK Taxes on Investments

UK taxes on investments are a type of capital gains tax. Depending on the type of investment, it may be referred to as a stamp tax. In the UK there are some rules for paying taxes on investments. When purchasing a share, there is a 0.5% tax on the exchange. If this exchange occurs electronically, there is a Stamp Duty Reserve Tax, and if it occurs using a stock transfer form and exceeds £1,000, then it is subject to Stamp Duty. Additionally, if the share is transferred to a third party like a bank, buyers must pay a 1.5% tax.

When you are the one selling the shares, you may be subject to capital gains tax. The first £12,300 earned is not taxed, but any money earned above this is taxed at 10% if your income falls in the Basic Tax band and 20% if it falls in the High Tax band.8

Earnings on dividends are also taxed. A dividend is money paid by companies to their shareholders. Currently, in the UK shareholders must pay taxes on dividend income that exceeds £2,000 per tax year.9 Above this limit, the amount of tax shareholders pay on their dividends can be seen in Table 4.

Tax BandTax Rate
Basic Rate8.75%
High Rate33.75%
Additional Rate39.35%
Table 4. Tax rate on dividends above £2,000. Source: Gov.uk

UK Taxes vs US Taxes

UK taxes vs US taxes are very similar when it comes to how the two systems are set up. They vary in the amount taxpayers pay annually.

As a whole, citizens and residents of the UK pay more in taxes. The highest rate of income tax in the US for taxes due in 2022 is 37% for the highest tax bracket, which includes people earning over $523,600 annually.10 In the UK the highest tax band for taxes due in 2023 has people who earn £150,000 or more paying 45% income tax.3

The current rate that US taxpayers pay monthly for Social Security if they are an employee or the employer is 6.2% for each.11 If you are self-employed it is 12.4%.11 Where the US has one rate regardless of income, the UK has its NIC rates depending on the weekly earnings of the taxpayer, which are 13.25% for the lowest band that qualifies for NIC, which is higher than the Social Security monthly contribution.

The US equivalent to VAT is sales tax. In the US, each state is responsible for setting its sales tax rate. Typically, state sales tax is between 2.9-7%.12 This is also significantly below the 20% VAT that UK taxpayers must pay on most goods and services. Of course, there are exceptions to these rules, such as taxes applied to the sale of tobacco and alcohol products that may be subject to additional "sin taxes."

You may be asking yourself, "why does the UK have such steep taxes?"

While, yes, the UK pays higher taxes overall, they have lower costs on private expenditures for things like healthcare and childcare. The UK parliament uses the taxes collected to fund its social programs that benefit its population. While the UK does have higher taxes, they do not have to pay for things like medical attention and childcare as in the US, but US workers get to take home more of their paycheck and choose how to spend their money.

You've learned quite a bit about taxes in the United Kingdom, but how familiar are you with taxes in the United States? Check out our explanation - US Tax!

UK Taxes - Key takeaways

  • In the UK the tax rate is set by an organization called HMRC and they are responsible for collecting taxes and making funds available for the public benefit.
  • The three main taxes in the UK are income tax, National Insurance Contributions, and value-added tax.
  • The UK utilizes a progressive tax system which means you pay a higher tax rate as your income increases.
  • The UK has a PAYE system that automatically deducts income taxes and NIC monthly.
  • The UK and the US have similar tax systems, but UK taxpayers pay more taxes in total than US taxpayers.

References

  1. Matthew Keep, Tax Statistics: an overview, House of Commons Library, June 2022,https://commonslibrary.parliament.uk/research-briefings/cbp-8513/#:~:text=The%20majority%20of%20receipts%20come,530%20billion%20in%202021%2F22.
  2. Gov.uk, Benefits and financial support for families, 2022, https://www.gov.uk/browse/benefits/families
  3. Gov.uk, Income Tax rates and Personal Allowances, 2022, https://www.gov.uk/income-tax-rates
  4. Gov.uk, National Insurance: introduction, 2022, https://www.gov.uk/national-insurance/how-much-you-pay
  5. Matthew Keep, Tax statistics: an overview, House of Commons Library, June 2022, https://commonslibrary.parliament.uk/research-briefings/cbp-8513/#:~:text=The%20majority%20of%20receipts%20come,530%20billion%20in%202021%2F22.
  6. Gov.uk, VAT rates, 2022, https://www.gov.uk/vat-rates
  7. Gov.uk, How VAT works, 2022, https://www.gov.uk/how-vat-works
  8. Gov.uk, Capital Gains Tax rates and allowances, 2022, https://www.gov.uk/guidance/capital-gains-tax-rates-and-allowances#tax-free-allowances-for-capital-gains-tax
  9. Gov.uk, Tax on Dividends, 2022, https://www.gov.uk/tax-on-dividends
  10. Ellen Chang and Kemberley Washington, 2021-2022 Tax Brackets and Federal Income Tax Rates, Forbes, September 2022, https://www.forbes.com/advisor/taxes/taxes-federal-income-tax-bracket/
  11. Social Security Administration, How is Social Security financed?, 2022, https://www.ssa.gov/news/press/factsheets/HowAreSocialSecurity.htm
  12. Janelle Fritts, State and Local Sales Tax Rates, 2022, Tax Foundation, February 2022, https://taxfoundation.org/2022-sales-taxes/

Frequently Asked Questions about UK Taxes

Taxes are high in the UK because the government provides services like universal healthcare and childcare. 

In the UK you pay higher taxes.

Yes, you have to pay taxes on investments in the UK. 

The 3 main taxes in the UK are income tax, National Income Contributions, and value added tax. 

In the UK income tax is calculated by subtracting the personal allowance from the total annual earnings. Then you pay 20% on any earnings between £12,571 to £50,270. If you earn between £50,271 to £150,000, then you must pay 40% on those earnings, and 45% on any earnings exceeding £150,000. The total amount owed in each band is the income tax owed. 

Final UK Taxes Quiz

Question

What is His Majesty's Revenue and Commons?

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Answer

The tax authority in the UK.

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Question

What are the 3 main taxes paid in the UK?

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Answer

Income tax, National Insurance Contributions, and value-added tax.

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Question

If Freddy earns £51,000 per year, how much income tax will he have to pay?

Show answer

Answer

\( 51,000-12,570=38,430 \)

\( 38,430 \times 0.2=7,686 \)


Freddy will have to pay £7,686 in income tax.

Show question

Question

What kind of system is it when as the taxpayer's income increases, their average tax rate increases?

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Answer

A progressive tax system.

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Question

True or False: The US has a progressive tax rate while the UK does not.

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Answer

False: They both have progressive tax rates.

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Question

What is the UK equivalent to paying into Social Security?

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Answer

Paying National Insurance Contributions. 

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Question

If Madison earns £1,500 per week, what is her NIC contribution?

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Answer

\( 1,500-241=1,259 \)

£1,259 taxable weekly income.

\( 967-241=726 \)

\(726 \times 0.1325=96.195 \)


\( 1,259-967=292 \)

\( 292 \times 0.0325=9.49 \)


\( 96.195+9.49=105.685 \)

Madison owes £105.69 NIC.

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Question

Are all goods subject to the same rate of VAT?

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Answer

No, the majority of goods are subject to 20% but goods like child seats and foods are subject to a lower rate or 0%.

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Question

Is VAT added to the sticker price of each good or at the check out counter?

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Answer

In the UK Vat is included in the sticker price of the item.

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Question

If you earned £4,500 in capital gains on your shares and you want to sell them, do you have to pay taxes?

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Answer

No, because it is under £12,300.

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Question

Does the UK have an inheritance tax?

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Answer

Yes.

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Question

What is the purpose of a tax?

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Answer

They are a means for generating an income for a government and as a means of regulation.

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Question

What is a capital gains tax?

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Answer

A tax that is applied to any profit earned from activities like buying and selling shares, or collecting dividends from those shares. (A capital gains tax is not limited to shares and dividends.)

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Question

Why might the amount of money a government earns be more than it collects in tax?

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Answer

Taxes are not the government's sole source of income. Other inflows of cash called receipts are interest payments, loan repayments, and sales. 

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Question

What is the UK's PAYE system?

Show answer

Answer

PAYE is a system that deducts taxes and NIC from each paycheck to avoid taxpayers having one large tax bill by having people pay as they earn their wages.

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