Experts project that reducing the income tax threshold for higher earners could generate approximately £9 billion for the Treasury. Chancellor Rachel Reeves has decided against deviating from Labour’s manifesto by increasing income tax rates in her upcoming Budget this November, a move that could potentially upset Labour MPs and voters.
Speculation suggests that Ms. Reeves abandoned the plan due to improved forecasts from the Office for Budget Responsibility, indicating a smaller expected deficit of around £20 billion rather than the previously estimated £30 billion. Nonetheless, this leaves the Chancellor with challenging decisions regarding tax increases and budget cuts.
According to the Financial Times, one proposal involves lowering the income tax thresholds for different earning brackets. Currently, individuals have 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 a 45% additional rate on higher incomes.
The Resolution Foundation suggests that reducing the higher rate threshold from £50,270 to £46,000 by 2029/30 could yield £9 billion in revenue. This amount surpasses the anticipated £6 billion from the previous plan, which involved a 2p increase in income tax and a corresponding reduction in employee national insurance.
While adjusting the threshold for higher-rate taxpayers may protect many lower earners, it could still impact an estimated 30% of the workforce, including numerous public sector employees.
Economists at Pantheon Macroeconomics propose that reducing all income tax thresholds by 10% could raise £17 billion by 2028/29. However, they acknowledge that such a measure might contradict the spirit of the manifesto and face political challenges.
Reports indicate that Ms. Reeves may not favor cutting 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 in April 2028, potentially generating £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 obligations as individuals’ incomes increase, pushing more earnings into higher tax brackets or exceeding the basic rate threshold.
The IFS warns that if the freeze continues, by 2029/30, even someone on minimum wage would need to work just 18 hours a week to be liable for income tax, the lowest level since the introduction of the minimum wage in 1999. Additionally, millions more individuals receiving the full new state pension could face tax liabilities by 2027/28 if they are not already paying taxes.
Matthew Oulton, a research economist at the IFS, highlights the significant impact of extending the tax threshold freeze, emphasizing that it would raise substantial revenue in an equitable manner affecting full-time and part-time employees, minimum wage workers, and low-income pensioners.
“The Chancellor may seek to enhance revenue and alter the tax burden, with adjusting thresholds being a reasonable strategy to achieve this goal,” Oulton concluded.