Analysis suggests that reducing the income tax threshold for higher earners could generate £9 billion in revenue for the government. Chancellor Rachel Reeves has opted out of a plan to revise Labour’s manifesto by increasing income tax rates in her upcoming Budget in November, citing concerns about potential backlash from Labour MPs and voters.
Speculation surrounds Ms. Reeves’ decision, possibly influenced by improved financial forecasts indicating a smaller budget deficit than previously estimated. Despite this positive development, the Chancellor still faces challenging decisions regarding tax increases and budget cuts.
One proposed option, as outlined by the Financial Times, involves lowering the income tax thresholds for different income brackets. Currently, individuals have a tax-free personal allowance of £12,570. Income between £12,571 and £50,270 is taxed at the basic rate of 20%, while earnings from £50,271 to £125,140 fall under the higher rate of 40%, with a top rate of 45% applying to incomes beyond that.
The Resolution Foundation suggests that decreasing the higher rate threshold from £50,270 to £46,000 by 2029/30 could yield £9 billion in revenue. This figure surpasses the projected £6 billion from an alternative plan considered by Ms. Reeves, involving a 2p increase in income tax alongside a reduction in employee national insurance contributions.
While adjusting the threshold for higher earners could protect many low-income individuals, it may still impact about 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, they note that such a measure could be politically challenging and might not align with the original manifesto spirit.
Reports indicate that Ms. Reeves may not favor reducing income tax thresholds, with speculation suggesting a potential extension of the freeze on personal tax thresholds and National Insurance for an additional two years starting in April 2028. This move, according to the Institute for Fiscal Studies (IFS), could raise £8.3 billion annually by 2030, with the effect often referred to as a “stealth tax” as it gradually impacts taxpayers as incomes rise.
The IFS warns that if the freeze continues, even individuals on minimum wage could reach the income tax liability threshold by working just 18 hours a week by 2029/30, the lowest level since the introduction of the minimum wage in 1999. Furthermore, more recipients of the full new state pension may be subject to taxation by 2027/28, if not already.
Matthew Oulton, a research economist at IFS, highlights the significant revenue implications of extending the tax threshold freeze, affecting a wide range of employees, including full-time workers, part-time workers, minimum wage earners, and low-income pensioners. This approach, he suggests, could be a strategic method for the Chancellor to increase revenue and redistribute the tax burden effectively.