Chancellor Rachel Reeves has decided not to proceed with the plan to increase income tax rates, which could potentially raise £9 billion for the Treasury. This move comes after better-than-expected news from the Office for Budget Responsibility, indicating a smaller projected deficit of around £20 billion instead of the previously anticipated £30 billion. Despite this, tough decisions lie ahead for the Chancellor regarding potential tax increases and budget cuts.
One proposed option, as suggested by the Financial Times, involves lowering the income tax thresholds at which different rates apply. Currently, individuals enjoy a tax-free personal allowance of £12,570, with the basic rate set at 20% for incomes between £12,571 and £50,270, followed by a higher rate of 40% for earnings between £50,271 and £125,140, and an additional rate of 45% for incomes exceeding that amount.
According to the Resolution Foundation, reducing the higher rate threshold from £50,270 to £46,000 by 2029/30 could generate £9 billion in revenue. This figure surpasses the estimated £6 billion that could be raised through alternative plans to increase income tax by 2p and lower employee national insurance by the same amount, a proposal previously under consideration by Ms. Reeves.
While adjusting the threshold for higher rate taxpayers could protect many low earners, it is anticipated to affect around 30% of workers, including numerous public sector employees. Economists at Pantheon Macroeconomics suggest that reducing all income tax thresholds by 10% could yield £17 billion by 2028/29. However, they caution that such a measure may deviate from the spirit of the manifesto and present political challenges.
Reports indicate that Ms. Reeves may not be inclined to reduce income tax thresholds. Instead, there is speculation that she might opt to extend the freeze on current personal tax thresholds and National Insurance for an additional two years starting from April 2028. This move could potentially generate £8.3 billion annually by 2030, according to the Institute for Fiscal Studies (IFS).
This strategy, known as a “stealth tax,” would result in higher tax burdens as individuals’ incomes increase, leading to more earnings being taxed at higher rates or exceeding the basic rate threshold. The IFS warns that if the freeze continues, by 2029/30, even someone on minimum wage might only need to work 18 hours a week to become liable for income tax, reaching the lowest level since the introduction of the minimum wage in 1999.
Moreover, the IFS predicts that by 2027/28, a significant number of individuals receiving the full new state pension could be subject to taxation if the freeze persists. Matthew Oulton, a research economist at IFS, highlights the impact of extending the freezes on personal tax thresholds, emphasizing the potential revenue gains and the broad-ranging implications for various groups, including employees, pensioners, and low-income earners.
Considering the need for additional revenue and potential changes in the tax landscape, adjusting income tax thresholds emerges as a viable option for the Chancellor to explore further.