Britain’s lowest earners will lose more money if tax thresholds are frozen for longer than they will if income tax is raised at the Budget, analysis for i reveals.
The annual amount people can earn before they start paying income tax – the personal allowance – is frozen until 2028, but the Chancellor is poised to extend this by up to two years at next week’s Budget.
Government sources have insisted that the move would not breach the Labour general election manifesto, which contained a promise not to increase the rate of income tax to avoid imposing a burden on “working people.”
But experts have said that for some lower earners, an increase in the income tax rate from 20 per cent to 21 per cent would actually be less financially burdensome than the fiscal drag effect of inflation, effectively rendering Labour’s pledge “invalid”.
Those working part-time on low wages would be hit the hardest by the decision to freeze tax thresholds instead of increase tax rates, the experts said.
Calculations by financial planners at Quilter suggest that if Labour unfroze the tax thresholds as planned – so that they started to rise in line with inflation from 2028 – and instead added 1p to the rate of income tax for every £1 earnt, then someone earning £20,000 a year would be £33 better off annually.
For those on even lower salaries, the savings would be more dramatic, with someone on £15,000 likely to be £83 a year better off.
However, the saving is small and those earning more than £25,000 a year will generally be better off from the thresholds staying frozen, as opposed to the tax rate being increased. This would see someone on a £35,000 salary save £117 per year.
Shaun Moore, tax and financial planning expert at Quilter, said: “Lower earners might actually benefit more if the freeze were lifted and an additional 1 per cent were added to income tax rates instead.
“This is because a larger portion of a lower earner’s income would fall below an increased personal allowance – as it did before the freeze – attracting 0 per cent tax on a greater proportion of their earnings.
“This results in only a small proportion of their income being exposed to an increased 21 per cent. As income levels move above average earnings a 1 per cent increase starts to become more painful though so would prove unpopular.”
He added: “The notion that Labour has not broken their manifesto pledge not to raise taxes on working people should they extend the freeze, would essentially be invalidated.”
The calculations from Quilter are based on annual inflation being 2 per cent, but more dramatic inflation would make the amount of extra tax paid by lower earners if thresholds are frozen more dramatic.
If the personal allowance rose by 2 per cent in 2028 and 2029, it would be £13,079 by the end of the decade.
This means someone on £20,000 would only pay tax on £6,921 of their salary. If income tax were to rise to 21 per cent, this would mean a tax bill of £1,453.
But with frozen bands and a 20 per cent tax rate, they would owe tax on £7,430 of their earnings, leading to a bill of £1,486.
In the early 90s, less than 4 per cent of adults paid more than the basic rate of income tax, but this has risen since then.
As recently has 2020 it stood at around 8 per cent, but the Conservative Government opted to freeze thresholds between 2021 and 2028. High wage growth in 2022 and 2023 pulled many people into paying higher tax, generating billions of pounds for the Treasury.
A one-year additional freeze would raise around £7bn extra a year, a boost for the Chancellor as she seeks to increase taxes in order to avoid cutting public spending.
But last year, Reeves suggested that she would end the multi-year freeze in thresholds as it has left more and more workers paying the higher rate of income tax.
“It does concern me that people on average earnings are paying more in tax because they are dragged into higher tax brackets. That is a sign of failure. The Government is picking the pockets of working people,” she said at the time.
But the Chancellor is now considering the policy after concluding that it would not break Labour’s manifesto promise not to increase income tax.
The manifesto stated: “Labour will not increase taxes on working people, which is why we will not increase national insurance, the basic, higher, or additional rates of income tax, or VAT.”
Other measures reportedly lined up for the Budget next week include an increase in fuel duty valued at up to 7p per litre, the expiry of temporary cuts to stamp duty and the scaling back of a tax break for entrepreneurs who sell on their start-up businesses.
In total, Ms Reeves has signalled she will seek to raise as much as £40bn extra a year in taxes, which she blames partly on what she calls a £22bn “black hole” in the public finances left by the Conservatives and partly on the need to top up public spending plans which would have led to cuts for most Whitehall departments.
