𝓤𝓷𝓲𝓽𝓮𝓭 𝓝𝓮𝔀𝓼

A ‘hidden’ tax hike which wasn’t mentioned at all in the Labour Budget last week will cost the average worker almost £100 this year. Chancellor John Healey did not make any reference to the levels of personal tax-free allowances which will apply from April when he unveiled his financial plans this week.

It means he decided to keep in place a policy which was set by his predecessor Rachel Reeves to continue a freeze on these allowances until 2030. That decision will cost a worker on the average wage £88 in the next tax year. That’s how much income tax for the average full-time salary of £40,911 would fall by if tax thresholds increased by the current rate of inflation of 3.5%. It’s just shy of the £100 payment that households in council tax bands A-D will be receiving this winter.

Freezing the allowances means that workers are hit by a ‘stealth tax’ where the taxman takes a greater share of their earnings as their wages go up due to inflation.

Rachel Reeves continued the policy of freezing the personal allowance until 2030, meaning that the thresholds set all the way back in 2021 by then chancellor Rishi Sunak will still be in place at the start of the next tax year, when they’re traditionally updated.

Freezing the allowance isn’t actually anything new. Chancellors have done it from time to time over the last 30 years, but never for this long. The last time it was done for more than one year was in the early 90s when Kenneth Clark held the allowance at £3,445 between 1992 and 1995.

The freezing of the allowance has been good news for the coffers of the Treasury but bad news for those of everyone else.

That’s because of something called ‘fiscal drag’.

When people’s wages increase but tax thresholds don’t, more of their salary is taxable. That results in more of their salary being subject to taxation and their tax bill increasing, even though the tax rates haven’t changed.

The average salary for a full-time worker in the UK was just over £33,000 a year when the personal allowance was first set to £12,570 in April 2021.

That meant that £20,500 of the average salary was subject to tax, which is just under two thirds (62%). It would result in a tax bill of £4,098.

Fast forward to today and the average full-time salary is £42,138 a year, but the thresholds have remained the same.

That means £29,600 of the salary is taxable, 70% of it, leading to an income tax bill of £5,914. The average UK salary is projected to reach £44,700 by 2030, based on predicted interest rates. A frozen allowance at that stage would mean that £32,100 of the average salary would be taxable, which is almost three quarters of the total (72%), 10 percentage points higher than when the threshold was first set to that level.

It would produce an income tax bill of £6,430 which is £2,331 higher than when the threshold was set, despite the rates of income tax being unchanged.

Had thresholds been growing in-line with wages, then the allowance would be around £15,500 today. That would mean someone on the average salary would have an income tax bill of £5,071 as opposed to the £5,668 that they face today.

Maike Currie, VP Personal Finance, PensionBee, comments, “Fiscal drag is the ultimate stealth tax. By freezing income tax thresholds while wages rise, the Chancellor is quietly plucking more money from people’s pockets without ever having to announce a headline tax rise.

“PensionBee research in the run up to the Budget found 69% of savers want the Personal Allowance unfrozen, with 43% calling for immediate action. As highlighted in The Pension Confident Podcast, it’s a classic case of plucking the goose for the maximum amount of feathers with the least amount of hissing.

“It is particularly punitive for ordinary working people, including teachers, nurses and other public sector workers, who may receive a pay rise designed to keep pace with inflation, only to find more of their earnings swallowed up by tax.

“Many people are finding that instead of a pay rise making them better off, it’s pushing them into a higher tax bracket. One way to soften the blow is to pay more into a pension, potentially keeping your taxable income below a higher tax threshold, or reducing your adjusted net income to preserve valuable childcare support that might otherwise be lost.

“Freezing thresholds might be politically convenient, but it is far from painless. It’s a tax rise by stealth, and one that becomes more punishing with every passing year.”

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