The middle income trap – Econlib

In the United States, individuals living in poverty frequently encounter steep implicit marginal tax rates, as their benefits diminish with any increase in income. A recent article from The Economist sheds light on a parallel issue in the UK, particularly impacting the upper middle class, those with incomes exceeding £100,000:

Once a taxpayer hits the £100,000 mark, the elimination of the tax-free allowance results in a staggering 60% marginal tax rate for those fortunate enough to secure a hefty paycheck. Now, when national insurance contributions and student loan repayments—essentially taxes—are factored in, an ambitious young professional can find themselves facing a 71% rate. We’re not quite back to the ’60s when The Beatles lamented about “one for you, 19 for me,” but we’re not far behind. The Conservative government’s introduction of generous childcare allowances—worth tens of thousands—excludes this segment of earners. Hence, a family in London with two children under five finds themselves financially better off at £99,999 than at £149,000. Tax experts often explain that these rates prevent severe financial penalties when income crosses specific thresholds; however, in England, earning just £1 over £100,000 can lead to significant losses.

Such high implicit marginal tax rates serve as a disincentive for wealth creation. A graph presented in the article illustrates the clustering of taxpayers just below the £100,000 threshold, likely a result of hesitating to take on additional work that could push their earnings past levels where they would forfeit valuable child tax benefits:

Consider a scenario where the UK initially implemented a program granting all taxpayers access to the child allowance. Would a libertarian advocate for “means-testing” to exclude those earning above £100,000? On one hand, this approach could reduce government expenditure; on the other, it would exacerbate the implicit marginal tax rate, making it more challenging for individuals to escape the middle-income trap.

The U.S. may soon grapple with a similar challenge regarding its Social Security program. Anticipating calls for reduced benefits for earners above a certain threshold, we must recognize that this would effectively act as a tax on savings. Those who diligently saved to complement their Social Security could soon find their efforts undermined. If Americans respond by saving less, we could see a detrimental impact on the trade deficit.

As I delve into the intricacies of contemporary British politics, it’s striking to observe how the modern Conservative Party has seemingly dismantled the supply-side triumphs achieved during Margaret Thatcher’s era. The Economist has published two additional articles that reflect on the UK’s recent economic struggles. One article discusses the country’s failure to capitalize on opportunities following its exit from the EU, particularly in making its airline sector more competitive:

The Competition and Markets Authority (CMA), a regulatory body, has long advocated for such market reforms. While Rishi Sunak’s Conservative government seemed keen, the current Labour administration has different priorities, deciding that an incredibly complex battle with entrenched interests isn’t worth the effort.

This exemplifies how Britain has managed to engineer the worst possible outcome from Brexit. With slot regulations previously dictated by EU law, there existed a rare opportunity to liberate the market from protectionist rules that favor outdated national champions. Instead of embracing a “Singapore-on-Thames” vision welcoming giants like Singapore Airlines, Britain has lost access to the EU market, weakening competition for British firms, while doing little to simplify regulations that could have spurred growth.

Another article indicates that the British populace is increasingly regretting the decision to leave the EU:

The widening gap in public sentiment can be partly attributed to the demise of Brexit supporters:

During the electoral campaign, Labour tirelessly focused on swaying undecided Conservatives. However, the Grim Reaper played his part effectively. Between 2019 and 2024, a number of Conservative voters died off equal to those who switched allegiance to Labour.

The influence of the deceased extends beyond the ballot box; they represent a significant faction of Brexit supporters. Two-thirds of those who passed away post-2020 were proponents of leaving the EU.