Having dropped plans to breach Labour’s manifesto and increase income tax rates in the Budget, Rachel Reeves is widely expected to turn to another revenue-raising measure: extending the freeze on personal tax thresholds.
Despite the chancellor warning last year that prolonging the freeze would “hurt working people”, it is now on track to be the biggest single Budget measure as she aims for a fiscal consolidation of close to £30bn next week.
Delaying the end of the freeze would not be a direct breach of the manifesto, but critics argue that the decision by successive governments not to raise thresholds in line with inflation is a “stealth” tax measure.
Since when have the thresholds been frozen?
In 2021, then Conservative chancellor Rishi Sunak announced a four-year freeze in thresholds for the basic, higher and additional rates of income tax, between April 2022 and April 2026.
The policy — which increased tax receipts as higher pay led more workers to enter the tax system or to pay higher rates — was aimed at raising revenue for the government in the wake of the Covid-19 pandemic.
At present, people can earn £12,570 before they start paying UK income tax. For the next £37,700 they earn, they pay the basic rate of 20 per cent in England, Wales and Northern Ireland.
Between £50,270 and £125,140, they pay the higher rate of 40 per cent. Tax of 45 per cent is levied on income above £125,140. Scotland has different thresholds and rates.
Once people earn more than £100,000, they start losing the £12,570 tax-free personal allowance. They lose £1 of their personal allowance for every £2 that their income goes above £100,000, resulting in an effective tax rate of 60 per cent for some.
In 2022, Jeremy Hunt, Tory chancellor, announced a two-year extension to the freeze on thresholds while cutting the additional rate threshold from £150,000 to £125,140. Thresholds applying to national insurance contributions have also been subject to a series of freezes.
In the October 2024 Budget, Reeves said she would not extend the freeze beyond April 2028. “I have come to the conclusion that extending the threshold freeze would hurt working people,” Reeves told MPs. “It would take more money out of their payslips.”
How much money would an extension raise?
Extending the existing freeze on personal tax thresholds from 2028 until 2030 would generate some £8.3bn a year by the end of the decade, according to estimates from the Institute for Fiscal Studies think-tank.
Stronger wage growth could mean the policy yields even more, in a further boost to the cash-strapped Treasury.
Nimesh Shah, chief executive of advisory firm Blick Rothenberg, said ministers “don’t have many options to raise big sums of money, but this is one”.
Tax experts think Reeves could extend a freeze on other thresholds in the Budget.
These include the inheritance tax threshold, which allows people to inherit up to £325,000 before the levy is applied and has been unchanged since 2009, as well as the personal savings allowance. It allows savers to earn some money interest-free without paying tax, and has been frozen since it was introduced in 2016.
A separate allowance that lets people make gifts free of inheritance tax has remained unchanged at £3,000 a year since its inception in 1981.
What would the impact on taxpayers be?
Because of rises in wages alongside high inflation since the freeze first took effect, millions of taxpayers have begun paying tax on their earnings or been pulled into higher bands — a phenomenon known as ‘fiscal drag”.
Extending the freeze until 2030 would bring 1mn more people into the income tax net, and the total number of taxpayers in the UK to 42.1mn — or 73 per cent of people aged 16 or over, according to the IFS.
The policy would also bring the number of higher rate taxpayers to 10.1mn, meaning one in four employees was subject to the 40 per cent rate.
“It’s a way of raising tax by stealth . . . it’s the fiscal equivalent of searching for money down the back of the sofa,” said Clare Munro, senior tax adviser with Weatherbys Private Bank.
Despite the impact of fiscal drag, some analysts have said that the UK’s effective tax rates on employment, in particular for lower earners, remain low by G7 and OECD standards.
Are there political risks?
Reeves and Prime Minister Sir Keir Starmer last week ditched a planned income tax rise, which would have risked a voter backlash given that Labour pledged not to increase rates of income tax, VAT or national insurance during the 2024 general election campaign.
The roughly £30bn fiscal consolidation that Reeves is targeting will be built on an extension in the tax thresholds’ freeze and a host of other measures, as the chancellor takes a “smorgasbord” approach to raising revenue.
A person briefed on Reeves’ thinking previously said an extension in personal thresholds would not breach the manifesto, although she could face charges of hypocrisy in view of her pledge in the October 2024 Budget.
Shah said: “Though it won’t break the manifesto pledge, it still amounts to putting up taxes for working people.”
The Treasury said: “We do not comment on tax speculation outside of fiscal events.”
