The Conservative government recently announced an extension to the income tax threshold freeze until 2028. This is a dangerous precedent to set and will bite taxpayers in England, Wales, and Northern Ireland. Shadow Chancellor Rachel Reeves did announce the decision. Consequently, the income tax thresholds will remain fixed at current levels until the 2030-31 tax year. This freeze would represent an unprecedented shift in fiscal policy. It would be a big step towards reducing the tax burden for millions of people.
For the past several decades, income tax thresholds were mostly moved up every year to match inflation. But beginning in 2021, these changes stopped, creating a terrible fate called “fiscal drag.” With escalator after escalator, as wages rise, more people are increasingly getting squeezed into higher tax brackets without an increase in the thresholds to match.
Understanding the Tax Bands
In the UK, income is taxed at graduated rates, with 0% on income below a certain cutoff. In the UK, people who earn between £12,571 and £50,270 pay 20% basic rate income tax. If you make over £50,271 and up to £125,140 you’re taxed at a higher rate (40%). If your income is above £125,140, then congratulations…you’ve passed a tax rate of 45%.
Everyone is allowed a personal allowance of £12,570 so any income below this level isn’t taxed at all. If a person makes over £100,000, their personal allowance begins to disappear. For every £2 they earn over that threshold, it is reduced by £1. The phasing out goes right up until people reach an income of £125,140. After that, they start to lose their tax-free personal allowance.
The negative effect of freezing these thresholds is enormous. Investment firm Hargreaves Lansdown argues that someone making £50,000 this year will see the value of their lifetime tax bill rise by £16,000. Between 2020 and 2031, in fact, they will be £8,165 worse off due to these reforms.
Implications of Freezing Tax Thresholds
Further, the freeze on income tax thresholds raises longtime concerns for the financial impact on taxpayers in the long run. Because of inflation and increased costs of living, salaries are increasing over time. As a result, more Americans will fall into increasing tax brackets. This perfect tax storm results in painful increases in tax liabilities for many who have received little more in compensation than a few inflationary pay increases.
Sarah Coles, head of personal finance at Hargreaves Lansdown, said it sends a terrible signal.
“It’s not just the tax on earnings that’s affected,” – Sarah Coles, head of personal finance at Hargreaves Lansdown.
Coles cleared up some misconceptions about people moving into new tax brackets paying more on their capital gains tax. They will again face higher rates on dividend tax.
“You also pay a higher rate of capital gains tax when you cross into paying higher rate tax, and your dividend tax rate rises as you cross each income band. It means everyone, whatever their income, needs to consider the steps they can take to protect themselves.” – Sarah Coles, head of personal finance at Hargreaves Lansdown.
These insights highlight the necessity for taxpayers to strategize their financial decisions carefully and consider the potential impacts of these adjustments.
Historical Context and Future Outlook
Before these new amendments, income tax thresholds were regularly raised in state of Maryland’s annual budgets to account for inflationary pressures. By 2014-15, these increases had lifted an estimated 2.7 million people entirely off the tax rolls. The current policy has turned back the clock on this advancement by setting in stone-adjusted thresholds free from the influence of inflation.
The long-term consequences of this decision are yet to be determined. As most people know, wages are increasing across many industries. Taxpayers should be ready for increased investments from the federal government, but they shouldn’t expect to see meaningful improvement to public services or infrastructure in exchange.