Top Income Inequality and Tax Policy

How much income do the ‘rich’ get? From what activities does it arise? And how much tax do they pay? These questions are central to debates about discrimination and appropriate policy solutions. In a July 2021 survey, 58% of Britons were “worried” that “the top 1% of earners have more money than the other 99%”, and 42% agreed with the statement “The rich won’t be able to keep getting richer – it worries me”. ” (Garrett and Day 2021).

One reason for the renewed focus on income inequality is that the share of income flowing to the very top of the distribution has increased and is now much higher than in the early 1980s. This increase is evident in several English-speaking countries, including Canada, the United States, and Australia, but is more modest in continental Europe and Japan (Atkinson et al. 2011, Alvaredo 2017).

Much has been written about the possible reasons for the rise in the top income share. Some theories suggest that rising incomes at the top partly reflect increases in efficiency or effort, with technological change and globalization allowing a smaller group to capture larger markets and reap larger returns (e.g. Rosen 1981, Atkinson 2003, Gabeux and Landier 2008, Kaplan and Rauh 2013, Murphy and Topel 2016). Others claim that income at the top reflects rents, which may rise, for example, when markets are not competitive and few people are able to capture benefits (e.g. Bertrand and Mullainathan 2001, Bivens and Mishel 2013).

In a recent chapter of the IFS-led Deaton Review of Inequalities (Delestre et al. 2022), we provide new evidence on top earners in the UK and how much they are taxed.

One of the most striking aspects of the UK (financial) income distribution is that those at the top are much more likely to derive their income from active business ownership. Figure 1 shows that active business income accounts for 21% of revenue income for the top 1% and 29% for the top 0.1%, compared to just 9% for adults outside the top 1%. This is similar to the pattern seen in the United States, where the importance of business income increases more sharply for the top 1% (Smith et al. 2019).

Figure 1 Sources of income for the top 50% of UK adults, 2018-19

Disagree: Employment income includes net of taxable employment benefits and employment-related expenses. Active business income measures dividend income paid to company owner-managers and income from self-employment and partnerships. Passive business income is dividend income paid to non-owner-managers. Other capital income includes all income from interest payments, trusts and other passive investments as well as income from property.
formula: Figure 3 from Delestre et al (2022).

This has important implications for the distribution of after-tax income because in the UK, as in many countries, business income is taxed at a substantially lower rate than employment income. Self-employment income tax is advantageous because this legal form is not equivalent to employer social security contributions which are charged on employment income. Investment income, especially including dividends, is not subject to any social security contributions. It benefits individuals running their own companies, who can choose to take income from their companies in the form of salary, dividends or capital gains. Company owner-managers can access a tax rate of just 27% on income up to £1 million retained in their company and realized as a capital gain – or 0% if the realization of the gain is deferred until death.

Despite the preferential tax treatment of business income, UK taxation on corporate income is overall progressive: average tax rates are higher for those with higher incomes, and the top 1% pay a disproportionate and increasing share of income tax. Various policy measures since 2010 have increased taxes on ordinary income, dividends and capital gains; As a result, after-tax top income shares have declined relative to pre-tax shares over the past ten years. Nevertheless, wide variation in the rates applicable to different types of income creates horizontal disparities; For example, an employee and a partner may receive similar returns on their work efforts but pay very different rates of tax. It also affects people’s behavior, with strong incentives to operate a business through a legal form or to take income as capital. Such a response limits policy options, including the ability to raise the top income tax rate. Current government estimates suggest that raising the top rate of income tax above 45% will yield little recovery, at least in part because people may shift income to lower-taxed forms.

Policymakers who want to raise more revenue can do so by raising tax rates on business and capital gains. However, the impact of taxes, including public response, depends not only on tax rates but also on the broader design of the tax system, including the tax base (Slemrod and Kopczuk 2002, Kopczuk 2005). Raising the tax rate on capital gains, given the current design of the tax base, will discourage some savings and investment. This is one of the main reasons why policymakers are inclined to lower capital gains rates. However, Mirrlees et al. (2011) argue that this trade-off can be largely avoided if the tax base is reformed so that, as far as possible, high rates do not discourage investment. With a reformed tax base, there will be a strong case for aligning tax rates across different sources of income.

Although a significant number of high-income individuals respond to taxes by changing income, there are other ways they can – and do – do so. This includes evasion including offshore tax havens (Alstadsæter et al. 2018). Other so-called ‘real’ margins of tax response include how much work should be done and in which occupations. This includes the involvement of individuals in innovation, which is particularly important because the creation of new ideas can benefit not only the innovators, but also their societies (driving economic growth and income more broadly). Akkigit et al. (2022) conclude that higher personal taxes negatively affect the amount of innovation. Another important response is migration (evidence for this is surveyed in Kleven et al. 2020).

Income inequality is clearly an important and major form of inequality, with income taxes serving as the main means by which governments collect large amounts of revenue from high-income earners. UK income tax reform has significant scope and could raise more revenue from the top if desired. But there are alternative ways to raise revenue from the ‘rich’ and tackle other aspects of inequality more directly. For example, while income taxes will clearly affect how much wealth is accumulated and inherited, changes to inheritance taxes could address such disparities more directly. More generally, policymakers should pay careful attention to the ways in which people respond in order to design policies that best achieve their goals.


Akcigit, U, J Grigsby, T Nicholas and S Stantcheva (2022), ‘Taxation and Innovation in the Twentieth Century’, Quarterly Journal of Economics 137(1): 329–85 (see also Vox column here).

Alstadsæter, A, N Johannesen and G Zucman (2018), ‘Who Owns Assets in Tax Havens? Macro Evidence and Implications for Global Inequality’, Journal of Public Economics 162: 89–100.

Alvaredo, F (2017), ‘UK Estimates of Top Income Shares 2013-2014 and 2014-2015: Note on Methods’,, Technical Note 2017/2.

Atkinson, AB (2003), ‘Income inequality in OECD countries: data and interpretation’, CESifo Economic Studies 49(4): 479–513.

Atkinson, AB, T Piketty and E Saez (2011), ‘Top Incomes in the long run of history’, Journal of Economic Literature 49(1): 3–71.

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Kaplan, SN and J Rauh (2013), ‘It’s the Market: The Broad-Based Rise in the Return to Top Talent’, Journal of Economic Perspectives 27(3); 35-56.

Kleven, H, C Landais, M Muñoz and S Stantcheva (2020), ‘Taxation and Migration: Evidence and Policy Implications’, Journal of Economic Perspectives 34(2): 119–42.

Kopczuk, W (2005), ‘Tax base, tax rate and elasticity of reported income’, Journal of Public Economics 89(11): 2093–119.

Mirrlees, J, S Adam, T Besley, R Blundell, S Bond, R Chote, M Gammie, P Johnson, G Myles and JM Poterba (2011). Tax by design, Oxford University Press.

Murphy, KM and RH Topel (2016), ‘Human Capital Investment, Inequality, and Economic Growth’, Journal of Labor Economics 34(S2): S99–127.

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Slemrod, J and W Kopczuk (2002), ‘Optimal Elasticity of Taxable Income’, Journal of Public Economics: 84(1), 91-112.

Smith, M, D Yagan, O Zidar and E Zwick (2019), ‘Capitalism in the 21st Century’, Quarterly Journal of Economics 134(4): 1675-745.

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