The new Prime Minister, Andy Burnham, is stepping into office with a significant economic challenge: the widespread impact of frozen income tax thresholds. This policy, initially introduced by former Prime Minister Rishi Sunak in 2021 and subsequently extended by subsequent chancellors, has led to more individuals paying income tax as wages rise, a phenomenon known as fiscal drag.
Burnham has acknowledged the issue, noting that the freeze on the personal allowance, currently set at £12,570, was a frequent topic during his by-election campaign. He has hinted at potential policy changes to address the growing tax burden on ordinary workers and pensioners.
The Impact of Frozen Tax Thresholds
The freeze on income tax bands means that while wages and the cost of living have increased, the thresholds for paying different tax rates have remained static. This has effectively created a stealth tax raid, as more income is captured by tax.
Recent estimates suggest that frozen tax thresholds could generate over £55 billion annually by 2030. This is due to a projected increase in the number of basic rate taxpayers, with figures indicating a rise from 27.4 million in the 2021/22 tax year to 31.4 million in the current year. Furthermore, an additional 3.3 million workers are expected to be drawn into the higher-rate tax band, and half a million more into the top rate of tax.
Pensioners are also affected. With the state pension increasing due to the triple lock, more individuals over the state pension age are finding their income nearing or exceeding the personal allowance, leading to increased tax liabilities. Reports indicate that over 70% of pensioners are now taxpayers.
If the personal allowance had kept pace with inflation (CPI) since 2021, it would have risen from £12,570 to an estimated £17,380. Similarly, the higher rate threshold, currently £50,270, would be around £69,504. The threshold for the additional rate of income tax, which was lowered by former Chancellor Jeremy Hunt from £150,000 to £125,140 in April 2023, would be approximately £207,300 if it had been uprated for inflation.
Analysis by AJ Bell suggests that basic rate taxpayers could be paying up to £700.36 more annually due to the freeze, a figure projected to rise to £960 by 2030. Higher-rate taxpayers are reportedly paying as much as £3,500 more per year.
Potential Policy Responses
Burnham has publicly expressed a desire to reform income tax. Speaking on the BBC's Question Time, he indicated a willingness to examine the personal allowance, stating, "On the personal allowance, I've heard on so many doorsteps, and I've said to my team, let's have a proper look at this and let's develop a policy."
While Burnham could opt to only adjust the personal allowance, tax experts have cautioned against piecemeal changes. The potential revenue generated by the freeze, estimated at over £55 billion by 2030, presents a significant fiscal consideration, especially given existing economic pressures and anticipated increases in defense spending.
Furthermore, Burnham has previously suggested a case for reintroducing a 50% top rate of income tax, a stance that has also been supported by Shabana Mahmood, who is expected to serve as his Chancellor. Currently, the top rate of tax is 45% for earnings above £125,140.
