What are progressive taxes, and how do they work?

Progressive taxes: at a glance

• What do I need to know? Progressive taxes are designed so that the more you earn, the more you pay.
• What does it mean for me? You could be paying more than necessary by taking all your income as a salary.
• Why does it matter? Structuring how you save and invest can help you avoid unnecessary losses and keep more of what you earn.

Progressive tax systems mean that higher earners pay a larger share of their income in tax. But with the right planning, you can make sure you protect your money and don't pay more than you need to.

In this guide, you’ll learn about progressive taxes and how they work, and how you can manage your money to keep more of what you earn.

What are progressive taxes?

A progressive tax charges you more money when you earn more or increase your wealth.

How do progressive taxes work?

Progressive taxes apply higher rates to wealthier individuals, and lower taxes to those with less. The idea behind a progressive tax is that, as a higher earner, you should contribute a greater proportion of your wealth.

HMRC only applies higher rates of tax on the portion of your income that fits within each bracket, not your whole earnings (more on this later).

Types of progressive taxes

There are various examples of progressive taxes in the UK, including:

Income Tax

The UK’s Income Tax is based on what you earn, increasing in bands as your salary rises.

There are three tax brackets in England, Wales, and Northern Ireland. Income earned below the lowest tax bracket is tax-free:

And six in Scotland:

Capital Gains Tax

Capital Gains Tax (CGT) charges a different rate depending on your Income Tax bracket.

Additional and higher rate taxpayers contribute 24% of any profits made from property sales, while basic rate taxpayers only pay 18% (after the annual £3,000 CGT allowance).

Stamp Duty

Stamp Duty Land Tax (SDLT) is applied when you buy a home for over £125,000. Unless you’re a first time buyer, when it only applies to homes bought for over £300,000.

HMRC increases the rate of SDLT charged as the value of the property gets higher, at the following rates:

*Transfer value refers to the market price of a property when it’s either gifted or transferred without money changing hands. Even if you don’t buy the property, you still pay SDLT based on its value.

Tax on dividends

HMRC charges tax on dividends. This applies to income you make from shares above a Personal Allowance of £500. HMRC has reduced the Personal Allowance a handful of times over recent years, so it’s important to check how much you can receive tax-free in case the amount changes.

Tax rates for dividends are based on your Income Tax bracket, meaning they’re inherently progressive. The current tax rates for dividends are:

Who is most impacted by progressive taxes?

Progressive taxes are designed to impact higher earners the most. Not only does HMRC apply higher tax rates to your top earnings, but you’re also unlikely to qualify for tax-free allowances.

For example, with Income Tax, once your income reaches £100,000 a year, your Personal Allowance starts decreasing. For every £2 you earn above £100,000, you lose £1 of your Personal Allowance. So, once you hit £120,000, you lose your full £10,000 allowance.

Protecting and preserving your wealth

It’s possible to minimise your losses to progressive taxes and protect your wealth. This may mean restructuring your finances to focus on:

• Pension contributions: Your pension contributions are tax-deferred, meaning you pay tax at withdrawal. Increasing your pension contributions could reduce your taxable income and allow you to withdraw it in retirement when your Income Tax bracket is likely to be lower. You can also withdraw 25% of your total pension tax-free.
• Tax-efficient withdrawals and allowances: HMRC affords tax-free allowances with some earnings. For example, you can earn up to £500 tax-free from dividends, as well as £3,000 profit from sales before paying Capital Gains Tax. Spreading your money across different investments could keep you from paying more in tax than necessary.
• Family allowances: If your partner earns less than their Personal Allowance each year, you can transfer £1,260 of your allowance to them annually. This could save up to £252 in tax on your joint income.
• The 50/50 rule: Income earned on property owned by married couples or civil partners is also taxed 50/50. So, if your partner falls into a lower Income Tax bracket, you could save on the tax paid on your earnings.
• Tax-free and high-interest savings: Tax-free savings, like the annual £20,000 ISA (Individual Savings Account) allowance, let you grow your money without paying more in tax. High-interest savings accounts can also help you grow the amount you take home after tax.

Progressive vs. regressive taxes

The opposite of a progressive tax is a regressive tax. Instead of scaling up to charge higher earners more, regressive taxes charge a flat rate to all taxpayers.

The criticism of regressive taxes is that they disproportionately affect those with less money. This is because the same increase in costs for lower-income individuals means that they spend a higher proportion of their wealth for the same outcomes.

For example, VAT (Value Added Tax) is considered a regressive tax, with the standard VAT rate charged at a flat 20%. This means all earners pay the same amount in tax for goods.

Frequently asked questions about progressive taxes

What are the advantages of progressive taxes?

Progressive systems are often considered a fairer way to apply tax, as you only start to pay more once you earn more money. This tax structure also supports those who are early into building their wealth by leaving them with more of their income to save or invest.

You can put more of your money into tax-deferred savings, like pensions, to minimise how much is lost to tax. So, you’re not without options as a higher earner. But you do need to consider how to structure your wealth to maximise tax efficiency.

A financial adviser can offer expert guidance and help you structure your wealth in the best way for you.

What are the disadvantages of progressive taxes?

You might feel negatively affected by progressive taxes as a higher earner, as you lose more of your wealth to tax.

For example, as your salary increases so does the level at which you pay Income Tax. When your salary increases above the next tax threshold, you take home a lower proportion of your overall earnings.

What’s the difference between progressive and proportional taxes?

Progressive and proportional tax systems both aim to spread the tax burden, so higher earners pay more than those with less. But they’re structured in different ways.

Proportional tax systems apply a single flat rate to all earners. This means everyone pays an equivalent amount of money based on their income. In a proportional tax system, higher earners pay a greater total, despite contributing the same percentage as lower earners.

Which countries have progressive tax systems?

Many of the largest economies in the world operate some progressive tax systems, including the UK, the US, Japan, Germany, and France.

For example, each of these countries applies income taxes in bands, with the rates increasing as taxpayers earn more.

Is Inheritance Tax a progressive tax?

Inheritance Tax (IHT) is not structured as a progressive tax in a traditional sense, as HRMC charges a flat 40% rate on all estates worth over £325,000. But it can have a greater impact on those with more money, who end up paying more in total.

It’s possible to reduce your Inheritance Tax bill, though. For example, anything you leave to a spouse or civil partner is exempt from IHT entirely, as are any gifts given more than seven years before you pass away.

Take home more of what you’ve earned

Progressive tax structures can see you pay more on what you earn. This can make it harder to build your wealth if you’re not maximising tax-free allowances and earnings.

Saving money in high-interest accounts can grow your wealth, helping you offset some of the impact of higher tax charges.

Open multiple high-interest savings accounts with Flagstone

Flagstone lets you manage multiple high-interest savings accounts.

All in one place, with one password.

Join Flagstone