The government's decision to freeze income tax thresholds is set to bring millions more individuals into the tax system, and push a substantial number into higher tax brackets, according to a recent report by the Institute for Fiscal Studies (IFS). This policy, implemented at a time of high inflation, means that as wages rise, more of people's earnings become taxable, or fall into higher tax bands, without any real increase in their purchasing power.
According to the IFS analysis, approximately 3.7 million additional people will be paying income tax by the 2029-30 financial year, a direct consequence of the personal allowance remaining fixed. Furthermore, the number of individuals subject to the 40% higher rate of income tax is projected to increase by 2.7 million over the same period. The additional rate of 45% is also expected to encompass an extra 800,000 people, significantly broadening the base of those paying the highest rate.
The policy of freezing tax thresholds was initially announced by the then-Chancellor of the Exchequer, Rishi Sunak, in 2021. It involves keeping the personal allowance, the basic rate threshold, and the higher rate threshold at their current levels until April 2028. This contrasts with the previous practice of typically increasing these thresholds in line with inflation, or at least by a set amount, to prevent 'fiscal drag' – where inflation pushes people into higher tax brackets.
The implications of this policy are far-reaching. While it serves as a significant revenue-raising mechanism for the Treasury, it places an increasing burden on households, particularly those experiencing wage growth that is merely keeping pace with, or falling behind, the cost of living. The IFS highlights that this is a 'stealth tax' as it doesn't involve an explicit increase in tax rates but rather expands the pool of taxable income and taxpayers through inflation.
Opposition parties have frequently criticised the government's approach to taxation, arguing that it disproportionately affects middle-income earners and those struggling with the cost of living crisis. The Labour Party, for instance, has often called for a fairer tax system, though their specific proposals regarding income tax thresholds have varied. The government, however, maintains that difficult decisions are necessary to manage the public finances responsibly.
The long-term impact of these frozen thresholds suggests a fundamental reshaping of the UK's personal tax landscape. A greater proportion of the working population will contribute to income tax, and a larger segment will face higher marginal rates, irrespective of substantial real-terms increases in their income. This trend is expected to continue until the thresholds are eventually unfrozen and adjusted for inflation.