Income Tax

Income tax is a tax that a government charges on the income earned by people and organizations during a set period, usually a year. It covers wages and salaries, self-employment earnings, business profits, interest, dividends, rent and pensions. Governments rely on it because it raises large sums, can be adjusted to people's ability to pay and is collected through employers and banks as well as by annual returns.

Income tax is the best-known form of direct tax, paid by the person who earns the income, in contrast to an indirect tax such as a sales tax that is built into prices. Most countries tax individuals through a personal income tax and companies through a separate corporate income tax. Rates, allowances and rules are set by national legislatures and administered by tax authorities such as the US Internal Revenue Service (IRS), HM Revenue and Customs (HMRC) in the UK, India's Income Tax Department and Pakistan's Federal Board of Revenue (FBR).

Think of income tax as a share of each pay packet set aside for public services. The first slice of what a person earns is often left untouched, so that basic living costs are covered. After that, the government takes a portion, and in most countries the portion grows on the higher slices of income, a little like a staircase where each step up costs a bit more.

For most workers, the employer takes the tax out of each payslip and sends it to the government. At the end of the year the numbers are checked, either automatically or through a tax return, and any overpayment is refunded while any shortfall is paid.

Calculations follow a broadly similar sequence across countries, even though the details differ:

1. Gross income is added up from all taxable sources, including employment, business, investment and property income.
2. Exempt items are removed. Some receipts, such as certain tax-exempt income from government bonds or savings schemes, are left out by law.
3. Deductions and allowances are subtracted to reach taxable income. Examples include a personal allowance, a standard deduction, pension contributions and charitable gifts.
4. Tax rates are applied band by band. In a progressive tax system each band has its own rate, so the marginal tax rate on the last unit of income is higher than the average rate on the whole.
5. Credits are subtracted from the tax due, and tax already deducted at source through payroll or withholding tax is set against the final bill.

Investment income is often treated differently from wages. Many countries tax gains on assets under a separate capital gains tax, and some apply lower rates to a dividend to reduce the overlap with company-level tax. Where a person earns income in two countries, residence rules and double taxation treaties decide which country taxes it first.

Britain introduced the first modern income tax in 1799, when Prime Minister William Pitt the Younger needed money to fight Revolutionary France. It was abolished in 1816, revived by Robert Peel in 1842 and has been levied every year since. The United States taxed incomes during the Civil War, but a permanent federal income tax came only after the Sixteenth Amendment was ratified in 1913. India's Income-tax Act of 1961 governed the tax for more than six decades until the Income-tax Act, 2025 took effect on 1 April 2026, replacing the old "previous year" and "assessment year" with a single tax year. Pakistan's main statute is the Income Tax Ordinance, 2001.

The two world wars turned income tax from a levy on the rich into a mass tax, and introduced payroll deduction. Top rates in the US and UK exceeded 90% at points in the 1940s to 1960s, before falling sharply from the 1980s under the influence of supply-side economics.

Income tax is one of the largest sources of revenue in rich countries. Across members of the OECD, personal income tax raises roughly a quarter of total tax revenue, alongside social security contributions and consumption taxes. Some examples as of 2026:

• United States. Federal rates run from 10% to 37%. For 2026 the 37% rate applies to taxable income above $640,600 for single filers, and most states add their own income tax.
• United Kingdom. Rates of 20%, 40% and 45% apply above a personal allowance of £12,570, and the main thresholds are frozen until April 2031, a policy that produces fiscal drag as wages rise.
• Gulf states. Saudi Arabia, the United Arab Emirates, Qatar and their neighbours levy no personal income tax on salaries, relying on hydrocarbon revenue and consumption taxes, though the UAE introduced a 9% corporate tax in 2023.
• Flat-tax countries. Several Central and Eastern European states, such as Bulgaria at 10%, charge a single rate on personal income.

Developing countries often collect relatively little income tax because many workers are in the informal economy and pay no tax on their earnings. They rely more heavily on trade taxes and sales taxes.

Supporters argue that income tax matches what people pay to their ability to pay and can narrow economic inequality, since higher earners pay larger shares. Critics on the right say high rates discourage work, saving and enterprise, and point to the Laffer curve as a reason to keep rates moderate. Critics on the left say income tax misses much of the wealth of the very rich, whose gains often go untaxed until assets are sold, and favour a wealth tax or higher capital gains rates.

Complexity is a common complaint across the spectrum. Deductions and credits create opportunities for avoidance and evasion, and tax competition between countries for mobile workers and profits limits how high rates can go. Some economists propose replacing it with a consumption-based tax, while others propose a negative income tax that merges tax and welfare into one schedule.

• Internal Revenue Service (IRS)
• GOV.UK: Income Tax rates and Personal Allowances
• OECD: Tax policy