Chancellor Rachel Reeves has decided to forego altering the income tax threshold for higher earners, a move that experts suggest could generate around £9 billion for the Treasury. This decision marks a departure from Labour’s initial plan to increase income tax rates as part of the upcoming Budget in November, a choice that may have incited backlash from Labour MPs and supporters.
Speculation surrounds the reason behind Reeves’ shift, with the Office for Budget Responsibility delivering a more optimistic financial forecast, projecting a smaller deficit of approximately £20 billion instead of the previously anticipated £30 billion. Nevertheless, the Chancellor still faces the challenging task of navigating between potential tax increases and budget cuts.
One proposed option by the Financial Times involves reducing the thresholds at which individuals are subject to varying income tax rates. Currently, there exists a personal allowance of £12,570 that exempts individuals from paying income tax. The basic rate of 20% applies to incomes between £12,571 and £50,270, followed by the higher rate of 40% for earnings between £50,271 and £125,140, with an additional rate of 45% for incomes exceeding that threshold.
The Resolution Foundation suggests that lowering the higher rate threshold from £50,270 to £46,000 by 2029/30 could potentially yield £9 billion in revenue. This figure surpasses the projected £6 billion from the alternative plan, which involved a 2p increase in income tax and a corresponding reduction in employee national insurance.
While adjusting the threshold for higher rate earners could protect many lower-income individuals, it would still impact around 30% of the workforce, including a significant portion of public sector employees. Pantheon Macroeconomics experts propose that a 10% reduction in all income tax thresholds by 2028/29 could generate £17 billion in revenue. However, they caution that such a move may deviate from the manifesto’s ethos and could pose political challenges.
Contrary to initial reports, it is suggested that Reeves may not favor reducing the income tax thresholds. Instead, there is speculation that she might extend the freeze on current personal tax thresholds and National Insurance for an additional two years starting from April 2028. This extension could potentially raise £8.3 billion annually by 2030, according to the Institute for Fiscal Studies (IFS).
Referred to as a “stealth tax,” this freeze would result in more of individuals’ income being taxed at higher rates as their earnings increase, or if they surpass the basic rate threshold. The IFS predicts that by 2029/30, individuals earning the minimum wage would need to work only 18 hours a week to become liable for income tax under the continued freeze, the lowest level since the introduction of the minimum wage in 1999.
Moreover, the IFS suggests that by 2027/28, an increasing number of people receiving the full new state pension could potentially be subject to taxation if the freeze continues. Matthew Oulton, a research economist at IFS, emphasized the significant impact of extending the freeze on personal tax thresholds, highlighting its broad-reaching consequences on various segments of the population.
In light of the potential revenue implications, Oulton noted that adjusting tax thresholds could be a viable strategy for the Chancellor to raise additional funds and redistribute the tax burden.