Taxes in PolicyEngine

This post provides an overview of how taxes are modelled in PolicyEngine UK. It details both existing taxes in the UK tax system and proposed/contributed taxes that are simulated within our platform. Each tax component is linked to its specific implementation in the codebase, making this post a technical reference for understanding how tax calculations are performed in the PolicyEngine UK microsimulation model.

The post is organised into three main sections. First, we explain direct taxes (income tax, national insurance, and capital gains tax), which are collected directly from individuals and businesses. Next, we cover indirect taxes (VAT and fuel duty) which are embedded in the prices of goods and services. Finally, we explore both existing property and land taxes (including stamp duty variations across UK nations, business rates, and council tax) and contributed/proposed taxes (such as carbon tax, wealth tax, land value tax, and others) that are modelled in PolicyEngine but not currently implemented in the UK.

Table 1 below summarises key metrics for each tax in the UK system, comparing PolicyEngine's 2025-26 fiscal year revenue projections with those from the government (such as the Office for Budget Responsibility) and showing the percentage difference between them. While PolicyEngine models interactions from instituting or repealing tax and benefit programmes, this chart shows only the direct revenue collected from each tax, for consistency with government reports. In the following sections, we dive deeper into each of these taxes, examining their structure, implementation, and distributional impact across income groups.

Table 1: Summary of UK tax revenue estimates for 2025-26 (£ billions)

Programme	PolicyEngine	Government	Agency	Difference
Income tax	322.2	328.7	OBR	-2.0%
National Insurance	179.7	198.8	OBR	-9.6%
Capital gains tax	17.3	16.2	OBR	+6.8%
VAT	198.6	182.1	OBR	+9.1%
Fuel duty	28.3	27.3	OBR	+3.7%
Property transaction taxes	12.5	15.1	OBR	-17.2%
Business rates (England only)	24.3	27.8	DLUHC	-12.6%

Direct taxes are collected from individuals and businesses based on income, profits or gains. The three main direct taxes in the UK system—income tax, National Insurance, and capital gains tax—work together to tax different forms of income and wealth accrual. Our projections in this section are underpinned by data from the UK's Family Resources Survey (FRS) and the Survey of Personal Incomes (SPI), with validation against official HMRC statistics. In this post, all estimates provided are static estimates. PolicyEngine models behavioural responses to policy changes as well.

HMRC administers this tax using a band system with different rates for certain income types, implemented in PolicyEngine via the income_tax variable.

• Standard income tax components These are the main rate bands that determine tax payments on different portions of income. The UK uses a system where portions of income are taxed at different rates.

  • Basic rate: Applied to taxable income between the personal allowance and higher rate threshold at a rate of 20% for 2025, calculated in PolicyEngine as basic_rate_earned_income.
  • Higher rate: Applied to taxable income between the higher rate threshold (£37,700 above personal allowance in 2025) and additional rate threshold at a rate of 40% for 2025, calculated in PolicyEngine as higher_rate_earned_income.
  • Additional rate: Applied to taxable income over the additional rate threshold (£125,140 in 2025) at a rate of 45% for 2025, calculated in PolicyEngine as add_rate_earned_income.

• Income tax bases These represent the different sources of income subject to income tax in the UK. Each type has specific rules about deductions, allowances and sometimes different tax rates.

  • Employment income: Income from employment, including salaries, wages, bonuses and employment benefits. This income type is taxed through the PAYE system and represented by the taxable_employment_income variable.
  • Self-employment income: Income from self-employment, freelance work or running a business as a sole trader. Self-employed individuals pay income tax on profits after business expenses, calculated as taxable_self_employment_income.
  • Pension income: Income from state pensions, workplace pensions and private pensions, calculated as taxable_pension_income in PolicyEngine.
  • Property income: Income from renting out property, after deducting allowable expenses. This includes rental from UK and overseas properties owned by UK residents, calculated as taxable_property_income.
  • Dividend income: Income from company dividends, taxed at lower rates than other income (8.75% basic rate, 33.75% higher rate, and 39.35% additional rate for 2025). A dividend allowance of £500 for 2025 applies before dividend tax rates, with taxable amounts calculated as taxable_dividend_income.
  • Savings interest income: Interest earned on savings accounts, bonds and other interest-bearing investments. The personal savings allowance permits taxpayers to earn some interest tax-free, with eligible starter rate income calculated as savings_starter_rate_income.
  • Miscellaneous income: Other taxable income including royalties, trust income and casual earnings, calculated as taxable_miscellaneous_income.
  • Social security income: The UK taxes state pension, incapacity benefit, contributory jobseeker's allowance, contributory employment and support allowance, and carer's allowance. The UK does not tax other benefits such as universal credit and personal independence payment. PolicyEngine calculates this as taxable_social_security_income.

• Allowances and reliefs These are amounts that can be earned tax-free or deductions that reduce taxable income, defined by various parameters and calculated as part of allowances.

  • Personal allowance: The amount of income that can be earned before paying income tax, set at £12,570 in 2025-26. The UK reduces the personal allowance at a 50% rate when income exceeds £100,000. PolicyEngine represents this in the personal_allowance variable.
  • Marriage allowance: Allows a spouse or civil partner to transfer 10% of their personal allowance. Only available when the higher earner is a basic rate taxpayer and the lower earner has unused allowance, calculated as marriage_allowance.
  • Dividend allowance: Tax-free allowance for dividend income set at £500 in 2025, defined by the dividend_allowance parameter in dividend_allowance.yaml.
  • Trading allowance: The UK excludes up to £1,000 of trading income for self-employed individuals in 2025-26. Claiming this prevents deduction of business expenses from income, set through the trading_allowance parameter in trading_allowance.yaml.
  • Property allowance: The UK excludes up to £1,000 of property income from taxation in 2025-26. PolicyEngine represents this value in the property_allowance parameter in property_allowance.yaml.
  • Tax-free savings income: The UK exempts savings-interest income up to £1,000 for basic-rate taxpayers, £500 for higher-rate taxpayers, and £0 for additional-rate taxpayers in 2025. PolicyEngine applies this allowance through the savings-income bracketisation process in bracketized_savings_income, using the rates defined in savings_starter_rate_income.
  • Loss relief: Allows business or property losses to be offset against other income to reduce tax, calculated as loss_relief.
  • Capital allowances: Tax relief for businesses on the cost of purchasing assets used in the business. These allow businesses to deduct the cost of machinery, equipment and vehicles from taxable profits. PolicyEngine represents this in the capital_allowances variable.

• Income tax charges These are tax charges that withdraw benefits or allowances in specific circumstances, implemented in variables/gov/hmrc/income_tax/charges.

  • Child benefit high income tax charge (HITC): A tax charge on high earners who or whose partner receives child benefit. Child benefit rates in 2025 are £26.04 per week for the eldest child and £17.24 per week for each additional child. The HITC withdraws this benefit when income exceeds a threshold, with full withdrawal at a higher threshold, calculated as child_benefit_hitc.

PolicyEngine projects that the UK will collect £322.2 billion in income tax revenue in 2025, 2.0% less than the OBR's forecast of £328.7 billion. Figure 1 shows the distributional impact of this programme.

National Insurance operates alongside income tax and funds state benefits and the NHS. National Insurance consists of contributions paid by employees, employers and the self-employed, with overall liability calculated as national_insurance.

• Class 1 (Employees and employers) These are contributions paid on employee earnings above the primary threshold.

  • Primary contributions (employees): Paid by employees at 8% on earnings between the primary threshold (£241.73 per week in 2025) and upper earnings limit, with a lower rate above the upper limit. This is deducted via the PAYE system alongside income tax, calculated as ni_class_1_employee_primary.
  • Secondary contributions (employers): Paid by employers at a flat rate on employee earnings above the secondary threshold. This represents a cost for employers and affects employment costs, calculated as ni_class_1_employer.
  • Additional rate contributions: The UK levies a rate of National Insurance on employment income in excess of the upper earnings limit, calculated as ni_class_1_employee_additional.

• Class 2 (Self-employed - flat rate) A flat weekly rate paid by self-employed people with profits above the small profits threshold, calculated as ni_class_2.

• Class 3 (Voluntary contributions) Optional contributions people can make to fill gaps in their National Insurance record, calculated as ni_class_3.

• Class 4 (Self-employed - percentage-based) Percentage-based contributions paid by self-employed people on their profits. They function similar to income tax with different rates applied to different profit levels, calculated as ni_class_4.

  • Main rate: Paid on self-employed profits between the lower profits limit and upper profits limit, calculated as ni_class_4_main.
  • Additional rate: Paid on self-employed profits above the upper profits limit, calculated as ni_class_4_maximum.

PolicyEngine projects that the UK will collect £179.7 billion in National Insurance revenue in 2025, 9.6% less than the OBR's forecast of £198.8 billion. Figure 2 shows the distributional impact of this programme.

Capital gains tax applies to profits from asset sales, unlike income tax and National Insurance which apply to earnings. Capital gains tax is charged on the profit when selling or disposing of an asset that has increased in value. It applies to most assets including investments, second properties and business assets, but not main residences, calculated as capital_gains_tax.

• Basic rate (10%): Applied to gains for basic rate taxpayers on most assets (18% on residential property for 2025). The applicable rate depends on the taxpayer's income tax band and the asset type, defined by the basic_rate parameter.
• Higher rate (20%): Applied to gains for higher and additional rate taxpayers (28% on residential property for 2025), defined by the higher_rate parameter.
• Annual exempt amount: A tax-free allowance for capital gains set at £3,000 in 2025, defined by the annual_exempt_amount parameter.

Data imputation: Since capital gains are not directly observed in the Family Resources Survey (FRS) data, they are imputed using a joint distribution approach based on data from "Capital Gains and UK Inequality" paper by Arun Advani and Andy Summers. This dataset provides detailed percentiles of capital gains (p05, p10, p25, p50, p75, p90, p95) across more than 60 income bands, enabling the model to fit a spline to each band's percentiles to create a joint distribution. For each individual in the simulation, the probability of having capital gains is determined by their income band, and if they are modelled to have gains, the amount is randomly sampled from the relevant spline. These values are then uprated from 2017 to present day using the OBR's non-labour income forecast, allowing the model to accurately account for the concentration of capital gains among higher income individuals.

Behavioural responses: The PolicyEngine-UK model incorporates behavioural responses through the capital_gains_behavioural_response variable, which captures how individuals change realisation decisions in response to tax changes. This modelling is controlled by an elasticity parameter, which can be adjusted to simulate different levels of taxpayer sensitivity. For more information, you can read this post.

PolicyEngine projects that the UK will collect £17.3 billion in capital gains tax revenue in 2025, 6.8% more than the OBR's forecast of £16.2 billion. Figure 3 shows the distributional impact of this programme.

Residential properties are subject to council tax, except in Northern Ireland which uses domestic rates. Council tax is a local tax on domestic properties in England, Scotland and Wales, funding local services. In PolicyEngine, we apply the reported amounts from the Family Resources Survey data. Northern Ireland uses a rates system based on rental values rather than the banded approach of council tax, calculated as domestic_rates.

Indirect taxes are collected by intermediaries and passed to the government. They form part of the price of goods and services that consumers pay. Our indirect tax simulations rely on consumption data imputed to the Family Resources Survey dataset, calibrated to match aggregate statistics from HMRC and other government sources. In this post, all estimates provided are static estimates.

VAT generates revenue for the UK government. VAT is a consumption tax placed on products and services at each stage where value is added, calculated in PolicyEngine as vat.

• Standard rate (20%): Applied to most goods and services in the UK in 2025, defined by the standard_rate parameter.
• Reduced rate (5%): Applied to certain goods and services including domestic fuel and children's car seats in 2025, defined by the reduced_rate parameter.

The VAT calculation sums the tax from standard-rated items (consumption × 20%) and reduced-rated items (consumption × 5%), then divides by a factor to account for under-reporting. This approach ensures that modelled VAT revenue aligns with official government statistics.

Data imputation: The consumption data for VAT calculations comes from the Living Costs and Food Survey (LCFS), which follows the Classification of Individual Consumption by Purpose (COICOP) system. Due to under-reporting in survey data, the calculation is divided by 0.38 to match official HMRC VAT receipts. The model assumes that approximately 50% of consumption is subject to the standard VAT rate, while about 3% is subject to the reduced rate (primarily domestic fuel), as specified by the reduced_rate_share parameter. The remaining consumption is either zero-rated or exempt. Consumption data is uprated using the OBR's Consumer Price Index forecast.

PolicyEngine projects that the UK will collect £198.6 billion in value added tax (VAT) revenue in 2025, 9.1% more than the OBR's forecast of £182.1 billion. Figure 4 shows the distributional impact of this programme.

The UK applies excise duties to specific products, including fuels. Fuel duty is an excise tax charged on purchases of petrol, diesel and other fuels for vehicles or heating, calculated as fuel_duty.

• Petrol and diesel rates: Set at £0.5795 per litre for both petrol and diesel in 2025, defined by the petrol_and_diesel parameter.

PolicyEngine projects that the UK will collect £28.3 billion in fuel duty revenue in 2025, 3.7% more than the OBR's forecast of £27.3 billion. Figure 5 shows the distributional impact of this programme.

The UK tax system includes taxes on property ownership, occupation and transactions. These taxes vary by nation and property type. Our property tax simulations use property values from the Family Resources Survey enhanced with housing market data and transaction patterns. Property transaction taxes (SDLT, LBTT, LTT) are modelled assuming a 4.5% annual property turnover rate. All estimates in this section are static estimates that do not reflect potential changes in property ownership or transaction behaviour due to tax changes.

Since property transactions are infrequent events for most households, PolicyEngine's model employs a smoothing mechanism that converts one-time transaction taxes into expected annual values. Rather than simulating which specific households purchase property in a given year, our approach multiplies each household's potential tax liability by the annual property sale rate (4.5%). This provides a representation of the economic burden of transaction taxes across the population over time. First-time buyer relief eligibility is modelled probabilistically based on age brackets derived from HMRC statistics, and both residential and non-residential property transactions are included in the calculations. Corporate property tax incidence is also distributed to households based on shareholding patterns to provide a comprehensive view of property tax burdens.

The Office for Budget Responsibility (OBR) estimates that revenue from property transaction taxes, including Stamp Duty Land Tax (SDLT), Land and Buildings Transaction Tax (LBTT), and Land Transaction Tax (LTT), for 2025-26 is £15.1 billion.

SDLT is a tax paid when purchasing property over certain price thresholds in England and Northern Ireland, calculated as stamp_duty_land_tax. In PolicyEgine, the calculation splits into residential and non-residential components for both purchases and rentals. For residential properties, tax rates vary based on purchase type (first-time vs. subsequent, main vs. additional residence), with bracket taxation applying higher rates only to portions above each threshold. Additional properties face surcharges when exceeding minimum thresholds. Rental agreements are taxed on the net present value of rent. Corporate transactions distribute tax burden to households based on shareholding percentages and statistical revenue values. Expected revenue is calculated using a 4.5% annual property turnover rate, representing the estimated percentage of property value changing hands yearly.

• Residential property These rates apply to homes and residential properties with different structures for different buyer types, defined in residential.

  • Main residence rates (including first-time buyer relief): Standard rates apply in bands from the nil-rate band (£0) to portions over the highest threshold. For 2025, thresholds are £0, £125,000, £250,000, £925,000, and £1,500,000, with corresponding rates of 0%, 2%, 5%, 10%, and 12%. First-time buyers receive relief with higher nil-rate thresholds and reduced rates up to a maximum property value, defined in property-specific rate files within residential.
  • Additional property surcharge: An extra percentage of SDLT is charged on additional residential properties over a threshold, defined in the surcharge parameters within residential.
  • Rental agreements: SDLT applies to the net present value of rent over the lease term when exceeding a threshold, defined by residential rent parameters in rent.yaml.

• Non-residential property These apply to commercial property purchases like shops, offices and agricultural land, defined in non_residential.

  • Purchase rates: Rates apply in bands from the nil-rate band to portions over higher thresholds, defined by non-residential purchase parameters in purchase.yaml.
  • Rental agreements: SDLT applies to the net present value of commercial lease rent above a threshold, defined by non-residential rent parameters in rent.yaml.

PolicyEngine projects that the UK will collect £11.4 billion in stamp duty revenue in 2025. Figure 6 shows the distributional impact of this programme.

Scotland uses a different property transaction tax than England and Northern Ireland. Land and Buildings Transaction Tax (LBTT) is Scotland's equivalent to SDLT, applying to property and land transactions in Scotland, calculated as lbtt. PolicyEngine implements Scotland-specific rate schedules with brackets, differentiating between first-time buyers and standard purchases. Additional property transactions incur both standard tax plus a percentage-based surcharge on the entire property value, creating a higher effective rate on second homes. Rental agreements use net present value calculation, taxing only the difference between previous and current cumulative rent. The tax applies exclusively to Scottish residents through a country code filter. Expected revenue is calculated using a 4.5% annual property turnover rate, representing the estimated percentage of total residential property value changing hands yearly. Non-residential transactions use separate rate schedules for both purchases and rental agreements.

• Residential property Scotland's residential property transaction tax applies to home purchases with specific rates, defined in residential.

  • Standard rates: Rates apply in bands with thresholds at £0, £145,000, £250,000, £325,000, and £750,000 for 2025, with corresponding rates of 0%, 2%, 5%, 10%, and 12%, defined by the rate parameter.
  • First-time buyer relief: First-time buyers pay no LBTT up to a higher threshold than standard purchases, defined by the first_time_buyer_rate parameter.
  • Additional dwelling supplement: A surcharge applies to additional residential properties over a threshold, defined by the additional_residence_surcharge parameter.
  • Rental agreements: LBTT applies to the net present value of residential lease rent above a threshold, defined by the rent parameters in rent.yaml.

• Non-residential property These apply to commercial property transactions in Scotland with distinct rates, defined in non_residential.yaml.

  • Purchase rates: Rates apply in bands from the nil-rate band to portions over higher thresholds, defined by specific band parameters in non_residential.yaml.
  • Rental agreements: LBTT applies to the net present value of commercial lease rent above a threshold, defined by specific rent parameters in rent.yaml.

PolicyEngine projects that the UK will collect £669.0 million in land and buildings transaction tax revenue in 2025. Figure 7 shows the distributional impact of this programme.

Wales has its own property transaction tax system. Land Transaction Tax (LTT) is Wales' equivalent to SDLT, applying to property and land transactions in Wales, calculated as land_transaction_tax. LTT implements separate calculation pathways for primary residences and higher-rate properties, each with distinct progressive bracket structures. Unlike SDLT and LBTT implementations, no specific first-time buyer relief appears in the LTT coding structure. The tax applies to both property purchases and rental agreements, with rental calculations using an incremental approach on net present values. Geographic restriction ensures only Welsh households face LTT liability through country code comparison. Non-residential transactions use separate rate schedules for both purchases and rentals. Expected revenue is calculated by applying a 4.5% annual property turnover rate to the whole property stock, representing the estimated percentage of total residential property value changing hands yearly.

• Residential property Wales' residential property transaction tax applies to home purchases with its own rate structure, defined in residential.

  • Primary residence rates: Rates apply in bands with thresholds at £0, £180,000, £250,000, £400,000, £750,000, and £1,500,000 for 2025, with corresponding rates of 0%, 3.5%, 5%, 7.5%, 10%, and 12%, defined by the primary parameter.
  • Higher rates for additional properties: A surcharge applies to purchases of additional residential properties, defined by the higher_rate parameter.
  • Rental agreements: LTT applies to the net present value of residential lease rent above thresholds, defined by specific rent parameters in rent.yaml.

• Non-residential property These apply to commercial property purchases and leases in Wales with specific rates, defined in non_residential.yaml.

  • Purchase rates: Rates apply in bands from the nil-rate band to portions over higher thresholds, defined by specific band parameters in non_residential.yaml.
  • Rental agreements: LTT applies to the net present value of commercial lease rent with threshold and rate structures, defined by specific rental parameters in rent.yaml.

PolicyEngine projects that the UK will collect £388.3 million in land transaction tax revenue in 2025. Figure 8 shows the distributional impact of this programme.

The UK imposes annual taxes on property occupation, including business rates for non-domestic properties like shops, offices, and factories. At PolicyEngine, business rates are modelled as a corporate tax with incidence distributed to households based on their shareholding in the corporate sector. The model allocates the total business rates revenue from each UK nation (England, Scotland, Wales, and Northern Ireland) to households in proportion to their corporate wealth holdings through the business_rates variable. Business rates are set by central government but collected by local authorities. The economic incidence of business rates is represented by distributing the total revenue burden based on households' corporate wealth holdings, reflecting the assumption that business rates are ultimately paid by shareholders through reduced returns on investments.

• Corporate tax on non-domestic properties: Calculated as a percentage (the multiplier) of a property's assessed rateable value, defined in business rates statistics parameters in statistics.yaml.
• Regional variation (England, Scotland, Wales, Northern Ireland): Each nation sets its own multipliers and relief schemes, creating regional differences, defined in region-specific sections within statistics.yaml.

PolicyEngine projects that the UK will collect £24.3 billion in business rates revenue in 2025, 12.6% less than the UK government's estimate of £27.8 billion for England alone in 2025-2026. Figure 9 shows the distributional impact of this programme.

Beyond modelling the existing UK tax system, PolicyEngine also includes several proposed taxes that are not currently implemented. These allow users to explore potential policy reforms and understand their distributional and revenue implications. Our simulations of proposed taxes use a combination of existing Family Resources Survey data enhanced with wealth, consumption, and carbon emissions data from sources including the Wealth and Assets Survey and national environmental accounts. In this post, all estimates for these proposed taxes are static estimates.

Carbon taxes can be used to price emissions and influence production and consumption patterns. A carbon tax is a levy on carbon emissions required to produce goods and services, calculated in PolicyEngine as carbon_tax.

• Per-ton CO2 emission tax: A fixed monetary amount charged per ton of carbon dioxide equivalent emitted, defined by the carbon tax rate parameter in carbon_tax.yaml.

• Consumer and corporate incidence modelling: PolicyEngine models how the tax burden would be shared between consumers and producers in the carbon_tax variable implementation.

• Applied to carbon consumption: The tax applies to the carbon footprint of household consumption across categories, using household carbon intensity variables in carbon.py.

A wealth tax would apply to the total value of an individual's assets, calculated as wealth_tax.

• Annual tax on total household wealth: A percentage tax applied to a household's total net wealth above a threshold, defined by wealth tax rate parameters in wealth_tax.yaml.
• Progressive rate structure based on wealth brackets: Higher tax rates would apply to larger wealth holdings, similar to income tax bands, defined by wealth tax bracket parameters in wealth_tax.yaml.

Some wealth tax proposals exempt the main residence from taxation. This is a targeted wealth tax that would exempt one's main residence but tax other assets, calculated as non_primary_residence_wealth_tax.

• Wealth tax that exempts main residence: Applies only to assets beyond a household's primary home, defined by wealth tax exemption parameters in non_primary_residence_wealth_tax.yaml.
• Applied to all other wealth including secondary properties, financial assets, etc.: Would capture investment properties, shares, bonds, business assets and other wealth forms through the non-primary wealth components in non_primary_residence_wealth_tax.py.

Land value tax focuses on the value of land itself, not the buildings or improvements on it. Land value tax is a levy on the unimproved value of land, disregarding buildings or other improvements, calculated as land_value_tax.

• Tax on land value separate from improvements: Only the underlying land value is taxed, not buildings or developments on the land. This differs from council tax and business rates, which tax the combined property value, defined by land value tax rate parameters in land_value_tax.yaml.
• LVT includes the following components:
  • General land value tax: A base rate applied to all land values regardless of use or ownership type. This would capture land value derived from location and public infrastructure, included in the land_value_tax calculation.
  • Household land value tax: A rate applied specifically to land under residential use. This could replace council tax with a system not dependent on outdated valuations, included in the residential component of land_value_tax.
  • Corporate land value tax: A rate applied to commercially used land. This could replace or supplement business rates, potentially reducing business investment distortions, included in the commercial component of land_value_tax.

The UK government has introduced VAT on private school fees from January 1, 2025, ending the previous exemption for private education, calculated in private_school_vat.py in PolicyEngine. This policy change applies the standard 20% VAT rate to private school fees that were historically exempt from VAT as part of the general exemption for educational services.

• VAT applied to private school fees: The standard VAT rate would apply to fees currently exempt as educational services, defined by private school VAT rate parameters in private_school_vat.yaml.
• Modelling by household income: PolicyEngine models which household income groups would bear the burden of this tax in the private_school_vat implementation.
• Adjusts for actual private school attendance rates: The model accounts for varying private school attendance rates across income groups using the private_school_attendance_rate parameter.

PolicyEngine models the current UK tax system and potential reforms, with tax impacts presented by income decile. Users can analyse how changes to taxes affect government revenue and household incomes.