Chancellor Rachel Reeves has decided against increasing income tax rates as originally planned, potentially forgoing £9 billion in additional revenue for the Treasury. The move follows a more optimistic outlook from the Office for Budget Responsibility, which now projects a smaller budget deficit of around £20 billion instead of the previously anticipated £30 billion.
One proposed alternative, put forth by the Financial Times, involves reducing the income tax thresholds, particularly targeting higher earners. Currently, individuals enjoy a tax-free personal allowance of £12,570, with a basic rate of 20% on income between £12,571 and £50,270, a higher rate of 40% on income between £50,271 and £125,140, and an additional rate of 45% on incomes exceeding that amount.
According to the Resolution Foundation, lowering the threshold for higher rate taxpayers from £50,270 to £46,000 by 2029/30 could generate £9 billion in revenue, surpassing the potential £6 billion from the previously considered plan to raise income tax rates by 2p and reduce employee national insurance by a similar amount. While this adjustment would benefit many lower earners, it could still impact an estimated 30% of the workforce, including numerous public sector employees.
Pantheon Macroeconomics experts suggest that decreasing all income tax thresholds by 10% could yield £17 billion by 2028/29. However, they caution that such a move might contradict the manifesto’s original intent and pose political challenges. There are reports indicating that Rachel Reeves may opt to extend the freeze on 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 gradually increase the portion of income subject to higher tax rates as individuals’ earnings rise, affecting more taxpayers over time. The IFS warns that if the freeze continues, by 2029/30, even someone on minimum wage could be liable for income tax by working just 18 hours per week, the lowest threshold since the introduction of the minimum wage in 1999. Additionally, the freeze could lead to more recipients of the full new state pension becoming taxable by 2027/28.
The IFS emphasizes that extending the freezes on tax thresholds would constitute a significant tax hike affecting a wide range of individuals, including full-time and part-time employees, minimum wage workers, and many low-income pensioners. Matthew Oulton, a research economist at IFS, notes that adjusting tax thresholds could be a viable tool for the Chancellor to generate more revenue and redistribute the tax burden effectively.