Chancellor Rachel Reeves has decided not to proceed with plans to increase income tax rates in the upcoming Budget in November, which experts estimate could potentially generate £9 billion for the Treasury. This change in direction follows speculation that the Office for Budget Responsibility’s improved forecasts on public finances, suggesting a smaller deficit of around £20 billion compared to the previously anticipated £30 billion shortfall. Nevertheless, tough decisions remain for the Chancellor in navigating potential tax hikes and spending cuts.
One proposed option, as outlined by the Financial Times, involves lowering the income tax thresholds that dictate different tax rates. Currently, individuals benefit from a tax-free personal allowance of £12,570, with a basic rate of 20% applied on earnings between £12,571 and £50,270, a higher rate of 40% for incomes between £50,271 and £125,140, and an additional rate of 45% on earnings above that threshold.
The Resolution Foundation suggests that reducing the higher rate threshold from £50,270 to £46,000 by the year 2029/30 could potentially generate £9 billion in revenue. This approach, if implemented, would surpass the projected £6 billion under consideration by Ms. Reeves, which involved a 2p increase in income tax and a corresponding reduction in employee national insurance.
While such a move to cut thresholds for higher earners could shield many lower-income individuals, it is expected to impact approximately 30% of the workforce, including a significant number in the public sector. Pantheon Macroeconomics experts have also proposed that a 10% reduction in all income tax thresholds by 2028/29 could yield £17 billion, although they acknowledge the political challenges associated with such a measure.
Contrary to earlier rumors, reports indicate that Ms. Reeves may not be inclined to reduce 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 move, if implemented, could potentially raise £8.3 billion annually by the year 2030, according to analysis by the Institute for Fiscal Studies (IFS).
This strategy, often referred to as a “stealth tax,” could result in more of individuals’ income being taxed at higher rates as their earnings increase. The IFS warns that if the freeze persists, by 2029/30, even someone on the minimum wage might need to work only 18 hours per week to become liable for income tax, marking the lowest threshold since the introduction of the minimum wage in 1999.
Furthermore, the IFS projects that by 2027/28, an increasing number of individuals receiving the full new state pension could potentially be subject to tax if the freeze continues. Matthew Oulton, a research economist at IFS, emphasizes the significant impact of extending these freezes on personal tax thresholds, noting the broad impact on various segments of the population and the potential for raising substantial revenue in a progressive manner.
In light of these considerations, the Chancellor faces the challenge of balancing revenue generation and tax policy adjustments while navigating the implications for different income groups and sectors.