Chancellor Rachel Reeves is reconsidering her budget plans after experts projected that reducing the income tax threshold for higher earners could generate around £9 billion for the Treasury. This decision marks a shift from Labour’s manifesto promises to increase income tax rates, creating concerns among Labour MPs and voters.
Speculation suggests that the Office for Budget Responsibility’s improved financial forecast, indicating a smaller deficit of around £20 billion compared to the previous estimate of £30 billion, influenced Reeves’ decision. Despite the positive news, tough decisions loom for the Chancellor regarding potential tax increases and budget cuts.
According to the Financial Times, one proposal involves lowering the thresholds at which individuals pay varying income tax rates. Currently, the personal allowance stands at £12,570, exempting individuals from income tax. Earnings between £12,571 and £50,270 are taxed at the basic rate of 20%, with the higher rate of 40% applying to incomes between £50,271 and £125,140, and the additional rate of 45% for earnings beyond that threshold.
The Resolution Foundation suggests that reducing the higher rate threshold from £50,270 to £46,000 by 2029/30 could potentially generate £9 billion, surpassing the £6 billion projection under Reeves’ previous plan to increase income tax by 2p and reduce employee national insurance by a matching amount. While this adjustment would benefit many lower earners, it could impact approximately 30% of workers, including those in the public sector.
Pantheon Macroeconomics experts propose that decreasing all income tax thresholds by 10% could yield £17 billion by 2028/29. However, this measure could face political challenges as it deviates from the manifesto’s intentions. Additionally, reports suggest that 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, as per the Institute for Fiscal Studies (IFS).
This strategy, labeled a “stealth tax,” would gradually increase the portion of individuals’ income subject to higher tax rates as their earnings grow. The IFS highlights that if the freeze persists, by 2029/30, someone earning the minimum wage would need to work only 18 hours per week to meet the income tax threshold, the lowest level since the minimum wage’s inception in 1999. Furthermore, more individuals receiving the full new state pension may fall into the tax bracket by 2027/28 if the freeze continues.
Matthew Oulton, a research economist at IFS, emphasizes the significant impact of extending the tax threshold freeze, noting its broad-based and progressive revenue-raising effects. He suggests that altering thresholds presents a viable option for the Chancellor to enhance revenue and redistribute the tax burden effectively.