Sir Keir Starmer refused to rule out freezing income tax thresholds at Wednesday’s Budget, prompting concern that more people will begin payin extra tax by ‘stealth’.
At Prime Minister’s Questions on Wednesday, Sir Keir declined to answer a number of questions from opposition leader Kemi Badenoch on the issue of threshold freezes.
His refusal to answer came after chancellor Rachel Reeves had been expected to breach Labour’s manifesto promises and increase income tax as part of her plans to plug the gap in the public finances. The chancellor is instead widely expected to raise other taxes on 26 November.
Additionally, frozen tax thresholds could be used to raise more money for the Treasury, in effect rising taxes by stealth. Even if income tax rates are not increased, people could end up paying more tax as a result of the freezes.
The tax-free personal allowance was frozen at £12,570 until 2028 by the previous Conservative government. Freezing tax thresholds can create what economists call “fiscal drag” – more people are pulled into higher tax brackets as average earnings increase, but the thresholds stay the same.
Here we tell you all you need to know about income tax and the thresholds.
What is income tax?
Income tax is a tax paid on income, though not all types of income can be taxed. How much income tax a person pays is based on how much they earn above their personal allowance and how much of their income falls within each tax band.
The standard personal allowance has been £12,570 since 2021. This means that earners do not pay tax on the first £12,570 of their earnings in a financial year. The rate of tax then increases depending on how much they earn.
What are the thresholds and income tax bands?
These bands mean that 20 per cent tax is paid on earnings between £12,571 and £50,270. Earnings between £50,271 and £125,140 are subject to a higher rate of 40 per cent tax.
People who earn in excess of £100,000 start losing the £12,570 personal allowance. This goes down by £1 for every £2 earned above £100,000. The personal allowance does not exist for those earning above £125,140. There is also an additional rate of 45 per cent income tax on all earnings above that.
These rates apply in England, Wales and Northern Ireland, but different rates apply in Scotland.
What is the ‘stealth’ tax rise?
Since 2021, the income tax personal allowance has been frozen at £12,570. This is the amount that can be paid before income tax deductions begin. The measure has been criticised as a way for the Treasury to boost revenue from income tax without increasing its rates.
Rather than increasing with inflation or average earnings as in previous years, this allowance, and all rates, will remain frozen until at least 2028, unless Ms Reeves chooses to change this.
The basic rate of 20 per cent is then paid on any earnings between £12,571 and £50,270, the higher rate of 40 per cent on earnings between £50,271 and £125,140, and the additional rate of 45 per cent on earnings over £125,141.
The effect of this is what economists call “fiscal drag”, where more people are pulled into higher tax brackets as average earnings increase, but the thresholds stay the same.
The respected Institute for Fiscal Studies says these freezes will reduce household incomes by an average of £1,250 by 2025-26. Analysts also point out that the measure will take more from workers’ pockets than any of the recent drops in national insurance and income in recent years.
A recent report from the think tank explains that “the impact of threshold freezes has already been substantial.”
“Freezes to the thresholds at which the basic and higher rates of income tax begin to apply are alone expected to raise £39 billion a year in 2029–30 (roughly similar to the amount of revenue that would be raised by increasing all rates of income tax by 3.5 percentage points).”
What if Labour extended the freeze?
Adding two years to the freeze would raise between £7.5 and £8.3bn, and mean £140 extra tax paid by basic-rate employees each year from April 2028.
However, one million-plus earners whose income is above £125,140 – and so already pay the top rate of income tax – would not be affected.
According to the IFS, an extension would see 72.6 per cent of earners aged 16+ paying income tax by 2029/30 – up from 70.9 per cent if they remain the same, and 63.9 per cent had the freeze not been introduced.
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