Cutting the income tax threshold for higher earners is projected to generate approximately £9 billion for the Treasury, according to experts’ estimates. Chancellor Rachel Reeves has decided not to deviate from Labour’s manifesto by increasing income tax rates in her upcoming Budget in November, a move that has sparked concerns among Labour MPs and voters.
Speculation suggests that Ms. Reeves abandoned the plan due to better-than-expected news from the Office for Budget Responsibility, indicating a smaller budget deficit of around £20 billion instead of the previously forecasted £30 billion. Nevertheless, this leaves the Chancellor with challenging decisions regarding tax increases and budget cuts.
One proposed option, as suggested by the Financial Times, involves reducing the income tax thresholds. Currently, individuals enjoy a tax-free personal allowance of £12,570. Earnings between £12,571 and £50,270 are subject to the basic rate of 20%, while the higher rate of 40% applies to incomes between £50,271 and £125,140, with an additional rate of 45% for earnings exceeding that amount.
The Resolution Foundation has put forth a proposal to lower the higher rate threshold from £50,270 to £46,000 by 2029/30, potentially raising £9 billion. This amount surpasses the £6 billion that was under consideration by Ms. Reeves, involving a 2p increase in income tax and a corresponding reduction in employee national insurance.
While adjusting the threshold for higher-rate taxpayers could protect many lower earners, it is expected to impact approximately 30% of the workforce, including a significant portion in the public sector.
Economists at Pantheon Macroeconomics suggest that reducing all income tax thresholds by 10% could generate £17 billion by 2028/29. However, they caution that such a move might contradict the manifesto’s principles and could pose political challenges.
Reports indicate that Ms. Reeves may not be inclined to reduce income tax thresholds, with speculation mounting that she might extend the freeze on personal tax thresholds and National Insurance for an additional two years from April 2028. This extension could potentially raise £8.3 billion annually by 2030, according to the Institute for Fiscal Studies (IFS).
This strategy, known as a “stealth tax,” would result in more income being taxed at higher rates as individuals’ earnings increase. The IFS warns that continuing the freeze could lead to individuals on minimum wage becoming liable for income tax with minimal working hours, marking the lowest threshold since the introduction of the minimum wage in 1999.
Additionally, the IFS highlights that an increasing number of people receiving the full new state pension may face tax obligations by 2027/28 if the freeze persists.
Matthew Oulton, a research economist at IFS, emphasizes the significant impact of extending the freeze on tax thresholds, noting that it would affect various segments of the population, including full-time and part-time employees, minimum wage workers, and low-income pensioners. Oulton suggests that adjusting tax thresholds is a viable method for the Chancellor to raise revenue and redistribute the tax burden.