Chancellor Rachel Reeves has decided to abandon the idea of adjusting income tax rates in the upcoming Budget, a move that was expected to deviate from Labour’s manifesto. This change of plan, estimated to potentially generate £9 billion for the Treasury by reducing the income tax threshold for higher earners, comes amidst concerns about potential backlash from Labour MPs and voters.
Speculation suggests that the decision to scrap the proposed tax rate adjustments may have been influenced by a more positive economic outlook presented by the Office for Budget Responsibility. The improved financial forecast indicates a smaller deficit of around £20 billion, instead of the previously anticipated £30 billion shortfall, leaving the Chancellor with challenging decisions regarding tax increases and budget cuts.
One possible scenario discussed by the Financial Times involves lowering the thresholds for different income tax brackets. Currently, individuals enjoy a tax-free personal allowance of £12,570. Earnings between £12,571 and £50,270 are taxed at the basic rate of 20%, with the higher rate of 40% applied on incomes between £50,271 and £125,140, and the additional rate of 45% for earnings exceeding that amount.
According to the Resolution Foundation, reducing the higher rate threshold from £50,270 to £46,000 by 2029/30 could potentially raise £9 billion, surpassing the anticipated revenue under the previous proposal to increase income tax by 2p and decrease employee national insurance by a corresponding amount. While this adjustment would shield many lower-income earners, it could impact around 30% of the workforce, including a significant portion of public sector employees.
Economists at Pantheon Macroeconomics suggest that decreasing all income tax thresholds by 10% could generate £17 billion by 2028/29. However, they caution that such a measure might deviate from the manifesto’s principles and could pose political challenges. The notion of reducing thresholds raises concerns about its impact on working individuals unless the adjustments yield less revenue compared to potential income tax hikes.
Despite reports indicating a reluctance on Ms. Reeves’ part to cut income tax thresholds, there is speculation that she may opt to extend the freeze on current personal tax thresholds and National Insurance for an additional two years starting from April 2028. This extension could result in a yearly revenue increase of £8.3 billion by 2030, as projected by the Institute for Fiscal Studies (IFS).
Known as a “stealth tax,” the freeze would lead to more of individuals’ income being taxed at higher rates as their earnings grow, potentially pushing them beyond the basic rate threshold. By 2029/30, the IFS estimates that individuals on minimum wage could become liable for income tax by working just 18 hours a week if the freeze continues, marking the lowest threshold since the introduction of the minimum wage in 1999.
Furthermore, the IFS warns that millions more recipients of the full new state pension could face tax liabilities by 2027/28 if the freeze persists. Matthew Oulton, a research economist at IFS, highlights the substantial revenue implications of extending the freeze on personal tax thresholds, emphasizing its broad-based impact on various segments of the population, including full-time and part-time employees, minimum wage workers, and low-income pensioners.
Considering the potential revenue benefits and distributional impact, the Chancellor may view adjusting tax thresholds as a viable strategy to increase government income and redistribute the tax burden effectively.