Freezing Reeves’ threshold would leave low-income people worse off than raising taxes

Britons on the lowest incomes will lose more money if tax thresholds are frozen for longer than if income tax were increased in the Budget, analysis I reveals.

The annual amount people can earn before they start paying income tax – the personal allowance – is frozen until 2028, but the Chancellor is poised to extend it to two years in next week’s Budget.

Government sources insist the move will not breach Labour’s general election manifesto, which pledged not to increase the rate of income tax to avoid burdening working people.

But experts say that for some people on lower incomes, increasing the income tax rate from 20 per cent to 21 per cent would actually be less financially burdensome than the financial drag on inflation, effectively rendering Labour’s promise “null and void”.

Experts say those working part-time on low wages will suffer the most from the decision to freeze tax thresholds rather than increase tax rates.

Calculations by financial planners at Quilter suggest that if Labor unfreezes tax thresholds as planned – so they start rising in line with inflation from 2028 – and instead adds 1p to the income tax rate for every £1 earned, then someone will make a pound. 20,000 a year would be £33 a year better.

For those on even lower salaries, the savings will be more significant: someone on £15,000 is likely to be £83 a year better off.

However, the savings are small and those earning more than £25,000 a year will generally be better off if the thresholds remain frozen rather than increased. In this case, a person with a salary of £35,000 would save £117 a year.

Sean Moore, tax and financial planning expert at Quilter, said: “Low-income people could actually benefit more if the moratorium were lifted and an extra 1 percent was added to income tax rates instead.

“This is because most of the income of people on lower incomes will fall below the increased personal allowance – as it did before the freeze – resulting in 0% tax on most of their income.

“This results in only a small portion of their income being subject to the 21 percent increase. As income levels rise above average earnings, a 1 percent increase becomes more painful, although it will prove unpopular.”

He added: “The idea that Labor has not broken its manifesto promise not to raise taxes on working people if the moratorium is extended will essentially be invalidated.”

Quilter’s calculations are based on annual inflation of 2 percent, but sharper inflation will make the amount of extra tax paid by people on lower incomes if the thresholds are frozen more significant.

If the personal allowance rises by 2 per cent in 2028 and 2029, it will be £13,079 by the end of the decade.

This means a person with £20,000 will only pay tax on £6,921 of their salary. If income tax were to rise to 21 per cent, it would mean a tax bill of £1,453.

But with frozen bands and a 20% tax rate, they will have to pay tax on £7,430 of their income, resulting in a bill of £1,486.

In the early 1990s, less than 4 per cent of adults paid income tax above the basic rate, but this has risen since then.

As in the recent year 2020, it was around 8 percent, but the Conservative government decided to freeze the thresholds between 2021 and 2028. High wage growth in 2022 and 2023 has prompted many people to pay higher taxes, costing the exchequer billions of pounds.

An additional one-year freeze would raise an extra £7 billion a year, providing a boost for the Chancellor as she seeks to raise taxes to avoid government spending cuts.

But Reeves last year suggested she would end a years-long freeze on the thresholds because it would leave more and more workers paying a higher income tax rate.

“What really worries me is that average earners are paying more in taxes because they are being pushed into higher tax brackets. This is a sign of failure. The government is picking the pockets of working people,” she said then.

But the Chancellor is now reviewing the policy, having concluded it would not break Labour’s manifesto pledge not to raise income tax.

The manifesto said: “Labor will not increase taxes on working people, so we will not increase National Insurance, basic, increased or additional rates of income tax or VAT.”

Other measures said to be planned in next week’s Budget include an increase in fuel duty of up to 7p per litre, the expiration of a temporary stamp duty cut and cuts to tax relief for entrepreneurs who sell their start-up businesses. .

In total, Ms Reeves has signaled she will aim to raise an extra £40bn a year in taxes, which she blames in part on what she calls a £22bn “black hole” in public finances left by the Conservatives , and partly it is necessary to increase public spending plans, which would lead to cuts for most Whitehall departments.