UK Considers Raising Income Tax Threshold as Inflation Erodes Allowance
The government is reportedly looking at increasing the personal allowance to £15,570, a move that could offer financial relief but raises questions about funding and economic impact.
The UK government is reportedly considering a significant increase to the personal allowance, the amount individuals can earn before paying income tax. Sources suggest the threshold could rise from the current £12,570 to £15,570, a change that could provide financial relief to lower and middle earners.
The Frozen Allowance
The personal allowance has been frozen at £12,570 since 2021 and is currently set to remain unchanged until 2031. This freeze, along with frozen National Insurance thresholds, means that as wages increase and inflation persists, more individuals are being pulled into paying income tax or higher tax brackets. This phenomenon, often referred to as a "stealth tax," has been a significant contributor to government revenue, with estimates suggesting frozen thresholds could generate over £55 billion annually by 2030.
Research by the Institute for Fiscal Studies indicated that if the personal allowance had been increased in line with inflation since April 2021, it would now stand at £16,070. The gap between the current allowance and its inflation-adjusted value is projected to reach £4,870 by 2030-31, representing a substantial real-terms reduction in its value.
Potential Impact of an Increase
If the personal allowance were raised to £15,570, it would mean individuals could earn an additional £3,000 before owing any income tax. This change would particularly benefit lower earners, with modeling by the National Institute of Economic and Social Research (NIESR) suggesting that the lowest fifth of earners could be up to £600 per year better off. However, experts caution that while popular, such a move primarily reduces a burden on earners and does not address the underlying causes of the cost of living crisis.
Funding the Proposal
Increasing the personal allowance to £15,570 is estimated to cost the government approximately £20 billion. Proposals suggest this could be funded by reforming capital gains tax, which is levied on profits from assets like shares or property. Some suggestions include increasing capital gains tax rates, potentially aligning them with income tax rates, with speculation that rates could rise to a maximum of 45%. Another proposed funding source involves the Bank of England ending interest payments on bank reserves.
Political Considerations
The idea of raising the personal allowance has gained traction within the Labour party, with donor Dale Vince submitting proposals to increase the tax threshold and make the tax system fairer. Senior figures within Labour have reportedly reviewed these submissions. However, any such move would need to align with the government's fiscal rules, which may be constrained by rising borrowing costs. Economists suggest that the fiscal buffer available for such measures may have significantly decreased.
Expert Opinions Divided
Finance experts are divided on the merits of a personal allowance hike. While acknowledging its potential popularity and benefit to earners, some argue it's a temporary relief that doesn't solve broader economic issues. Others express concern that significant increases in capital gains tax could negatively impact economic growth, potentially trapping the UK in a cycle of sluggish growth and rising debt.