Chancellor Rachel Reeves is considering a plan to reduce the income tax threshold for higher earners, potentially generating an estimated £9 billion for the Treasury. This move involves deviating from Labour’s manifesto promise to increase income tax rates. The decision comes as concerns arise about potential backlash from Labour MPs and voters.
Speculation suggests that Reeves abandoned the idea following improved financial forecasts from the Office for Budget Responsibility, indicating a smaller deficit of around £20 billion compared to the previously projected £30 billion. Despite this, tough decisions lie ahead for the Chancellor regarding tax increases and budget cuts.
According to the Financial Times, one proposal under consideration is lowering the income tax thresholds. Currently, individuals enjoy a tax-free personal allowance of £12,570. The basic rate of 20% applies to incomes between £12,571 and £50,270, followed by a higher rate of 40% for earnings between £50,271 and £125,140, with an additional rate of 45% for incomes beyond that threshold.
The Resolution Foundation suggests that reducing the higher rate threshold from £50,270 to £46,000 by 2029/30 could potentially yield £9 billion. This figure surpasses the estimated £6 billion revenue from Reeves’ previous plan, involving a 2p increase in income tax and a corresponding reduction in employee national insurance contributions.
While adjusting the threshold for higher earners could protect many low-income workers, it may still impact around 30% of the workforce, including numerous public sector employees. Experts at Pantheon Macroeconomics propose that lowering all income tax thresholds by 10% could raise £17 billion by 2028/29, but acknowledge the potential political challenges associated with such a move.
Reports suggest that Reeves is hesitant to cut income tax thresholds and may instead opt to extend the freeze on personal tax thresholds and National Insurance for an additional two years from April 2028. This strategy, labeled a “stealth tax,” could raise approximately £8.3 billion annually by 2030, according to the Institute for Fiscal Studies (IFS).
The IFS warns that continuing the freeze could lead to individuals on minimum wage being liable for income tax after working just 18 hours a week by 2029/30, the lowest threshold since the introduction of the minimum wage in 1999. Moreover, more recipients of the full new state pension may find themselves subject to taxation by 2027/28 if the freeze persists.
Matthew Oulton, a research economist at IFS, emphasizes the substantial impact of extending the freeze on personal tax thresholds, highlighting the broad-based and progressive nature of the revenue increase. He notes that adjusting thresholds remains a viable tool for the Chancellor to generate more revenue and redistribute the tax burden effectively.