Experts estimate that reducing the income tax threshold for higher earners could potentially generate £9 billion for the Treasury. Chancellor Rachel Reeves has decided against deviating from Labour’s manifesto promises to increase income tax rates in her upcoming Budget in November, a move that could potentially upset Labour MPs and voters.
Speculation suggests that Ms. Reeves may have abandoned the plan due to improved forecasts from the Office for Budget Responsibility, indicating a smaller public finance deficit of around £20 billion rather than the previously projected £30 billion. Despite this positive news, tough decisions remain for the Chancellor regarding tax increases and budget cuts.
One proposal, as suggested by the Financial Times, involves lowering the income tax thresholds. Currently, there is a tax-free personal allowance of £12,570, followed by a basic rate of 20% for income between £12,571 and £50,270, a higher rate of 40% for income between £50,271 and £125,140, and an additional rate of 45% for incomes exceeding that amount.
The Resolution Foundation indicates that reducing the higher rate threshold from £50,270 to £46,000 by 2029/30 could potentially raise £9 billion, surpassing the £6 billion expected from Ms. Reeves’ previous plan involving a 2p income tax increase and a corresponding reduction in employee national insurance contributions.
While adjusting the threshold for higher rate taxpayers could protect many lower earners, it may still impact around 30% of workers, including those in the public sector. Pantheon Macroeconomics experts suggest that decreasing all income tax thresholds by 10% could generate £17 billion by 2028/29, although such a move could pose political challenges.
There are reports indicating that Ms. Reeves may not favor cutting income tax thresholds and might opt instead to extend the freeze on current personal tax thresholds and National Insurance for an additional two years starting in April 2028, potentially raising £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 earn more. The IFS highlights that if the freeze continues, by 2029/30, someone earning the minimum wage would need to work just 18 hours per week to be liable for income tax, the lowest level since the introduction of the minimum wage in 1999.
Moreover, the IFS warns that more individuals receiving the full new state pension could potentially start paying taxes by 2027/28 if the freeze persists. Matthew Oulton, a research economist at IFS, emphasizes that extending the tax thresholds freeze would lead to a significant revenue increase affecting various employee groups and low-income pensioners.
Considering the potential revenue benefits and impact on tax distribution, adjusting tax thresholds remains a viable option for the Chancellor amid the challenging economic landscape.