Cutting the income tax threshold for higher earners is estimated to potentially generate £9 billion for the Treasury, as per experts’ calculations. Chancellor Rachel Reeves has decided not to deviate from Labour’s manifesto plans and increase income tax rates in her upcoming Budget in November, amidst concerns of backlash from Labour MPs and voters.
Speculation suggests that Ms. Reeves abandoned the idea following a more positive fiscal forecast by the Office for Budget Responsibility, indicating a smaller deficit of around £20 billion instead of the previously anticipated £30 billion. Nevertheless, the Chancellor still faces challenging decisions regarding tax increases and budget cuts.
According to the Financial Times, one proposal involves lowering the thresholds for different income tax brackets. Currently, individuals enjoy a tax-free personal allowance of £12,570. Beyond that, the basic rate of 20% applies to income between £12,571 and £50,270, followed by a higher rate of 40% for earnings between £50,271 and £125,140, with an additional rate of 45% for incomes exceeding that.
The Resolution Foundation suggests that reducing the higher rate threshold from £50,270 to £46,000 by 2029/30 could potentially raise £9 billion, surpassing the £6 billion estimated under Ms. Reeves’ previously contemplated plan of a 2p income tax increase coupled with a reduction in employee national insurance.
While lowering the threshold for higher-rate taxpayers would protect many lower earners, it could still impact approximately 30% of the workforce, including numerous public sector employees.
Economists at Pantheon Macroeconomics propose that reducing all income tax thresholds by 10% could generate £17 billion by 2028/29. However, this move might clash with the manifesto’s spirit and pose political challenges, as highlighted by Rob Wood, the chief UK economist, and Elliott Jordan-Doak, the senior UK economist.
Reports indicate that Ms. Reeves may not favor cutting income tax thresholds, with expectations leaning towards extending the freeze on current personal tax thresholds and National Insurance for an additional two years starting April 2028. This extension could potentially yield £8.3 billion annually by 2030, according to the Institute for Fiscal Studies (IFS).
The prolonged freeze is termed a “stealth tax” because as people’s incomes increase, more of it gets taxed at higher rates or surpasses the basic rate threshold. The IFS projects that if the freeze continues, by 2029/30, someone on minimum wage would need to work only 18 hours a week to be liable for income tax, the lowest level since the inception of the minimum wage in 1999.
Moreover, the IFS warns that by 2027/28, many more recipients of the full new state pension could end up paying taxes if the freeze persists. Matthew Oulton, a research economist at IFS, emphasizes the significant revenue increase and broad-based impact of extending the freeze, affecting various employee categories and low-income pensioners.
Considering the need for additional revenue and tax distribution adjustments, adjusting tax thresholds remains a viable strategy for the Chancellor, as stated by IFS economists.