New Prime Minister Andy Burnham faces an immediate challenge in addressing the cost-of-living crisis, with the freeze on income tax thresholds emerging as a significant issue. The decision, initially made by former Chancellor Rishi Sunak in 2021 and extended by subsequent chancellors, has led to an increase in tax revenue for the Treasury and higher tax bills for many individuals.
Estimates suggest that frozen tax thresholds could generate over £55 billion annually by 2030. This occurs through a phenomenon known as fiscal drag, where rising wages push more people into paying income tax or higher tax brackets, even if their real income has not substantially increased. The personal allowance, currently set at £12,570, has remained unchanged since 2021.
Burnham has indicated an awareness of the issue, noting that the frozen personal allowance was a frequent topic of discussion during his by-election campaign. He has publicly suggested that the government should explore options for reform. In a previous appearance on the BBC's Question Time, Burnham stated, "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."
The freeze has impacted millions of taxpayers. HMRC figures indicate a projected rise in basic rate taxpayers to 31.4 million in the current tax year, up from 27.4 million in 2021/22. Furthermore, an estimated 3.3 million more workers are expected to be pulled into the higher-rate tax band this year, with an additional half a million facing the top rate of tax. Pensioners are also affected, with over 70% now reportedly paying income tax as the state pension approaches the frozen personal allowance threshold.
Analysis from AJ Bell suggests that the freeze could cost basic rate taxpayers up to £700.36 annually, a figure projected to rise to £960 by 2030. Higher-rate taxpayers are facing even greater increases, with current additional tax payments estimated to be as high as £3,500 per year.
If the personal allowance had been adjusted in line with the Consumer Price Index (CPI), it would have risen to an estimated £17,380. Similarly, the higher rate threshold, currently £50,270, would be around £69,504. The additional rate threshold was already reduced by former Chancellor Jeremy Hunt from £150,000 to £125,140, and if it had kept pace with inflation, it would apply to earnings above £207,300.
While Burnham has signaled a willingness to address the frozen thresholds, the precise nature of any changes remains unclear. Tax experts have cautioned against making minor adjustments. The government may also weigh the significant revenue generated by the freeze against public pressure for relief, particularly amidst existing economic pressures and increased defense spending commitments. Burnham has also previously suggested a potential return to a 50% top rate of income tax, a sentiment echoed by his likely Chancellor, Shabana Mahmood.