Chancellor should raise tax thresholds, say accountants

Chancellor should raise tax thresholds, say accountants

Mar 7, 2024

Amid rumours that the Chancellor plans to cut 2% off national insurance in the Budget, accountants warn that frozen thresholds are much more damaging

A 2% cut in national insurance is the cheaper option for the Chancellor Jeremy Hunt as he grapples with limited headroom to reduce the highest tax burden for 70 years.

The advantage of leaving income tax rates and thresholds unchanged is that many taxpayers will not benefit as only those of working age pay national insurance, estimated at 27.3 million employees. Also, higher earners pay a reduced rate of 2% over the 40p tax threshold of £50,271, limiting their potential gains compared with a blanket income tax cut.

Treasury analysis shows a 2% cut in the basic rate of income tax would cost £13bn while a 2% cut in employees’ NICs would cost £9bn.

The Resolution Foundation estimates that cancelling the personal allowance freeze in 2024-25 would cost about £7bn.

The reality is that millions of taxpayers are paying more tax as thresholds are frozen until 2028, following the PM’s decision in March 2021 to freeze rates from April 2022 when he was Chancellor. This was originally meant to last until 2026, but a year later it was extended to 2028. The basic rate threshold remains at £12,570.

Charlotte Sallabank, tax partner at Katten Muchin Rosenman LLP, said: ‘The personal allowance threshold has been frozen since 2021 and the current plan is for it to remain frozen until 2028.

‘The result of this freeze is that as salaries rise more people come within the taxable income bracket – this fiscal drag contributes to the high tax burden.’

Even with cuts to national insurance, the tax burden is unacceptably high for average earners.

Sam Dewes, tax partner at HW Fisher said: ‘A reduction to the main rate of NI by 2% would represent a tax cut of £448.60 next year for a worker earning £35,000. The Chancellor is potentially viewing NI cuts as a more affordable option for the government by targeting workers, rather than cutting income tax.

‘However, the cost of frozen income tax thresholds for the individual’s finances would remain high despite the Chancellor’s efforts.

‘The Chancellor should consider increasing the basic rate band, personal allowance, or personal savings allowance. More people are starting to understand fiscal drag and the impact it is having.

‘For example, the number of taxpayers paying 40% income tax has increased by more than 40% in the past three years. This includes individuals working in professions where they would not expect to be subject to a higher rate of tax.

‘Increasing the allowances would ensure that fewer people are dragged into the requirement to submit tax returns at a time when HMRC are already struggling to deal with this administrative burden.’

The frozen thresholds are punishing taxpayers, particularly in the face of soaring inflation in the last two years, which is only just back under control.

 

Adrian Young, tax partner at Hurst, said: ‘Estimates vary, but the consensus is that the additional tax take from freezing allowances dwarfs any giveaway that would be achieved via a small reduction in headline tax rates.

‘What I would like to see in the Budget is personal allowances and tax bands being realigned to inflation.

‘To illustrate how significant this measure might be, had the main personal income tax allowance kept up with inflation since it was frozen in 2021 at £12,570, it would now stand at around £16,000. That’s more than £3,000 for every single person earning £16,000 or more who is now subject to tax at 20%.

‘So, it’s easy to see how the current policy of freezing allowances has contributed to the UK suffering the highest rate of tax in 70 years – surely not a sustainable place to be, even given the economic headwinds we face.’

Any tax cuts need to be taken in the wider context of the country’s finances and there are concerns that politically driven measures would simply result in further austerity with reductions in spending on non-protected departments, leaving only the NHS, education and defence ringfenced.

PwC tax partner Christine Cairns said: ‘The IMF has recently warned against cutting taxes so that public borrowing can be curbed, but the Chancellor will no doubt be tempted by the ‘feel good’ factor that a reduction in income tax rates would bring.

‘A 2% cut has been speculated but due to the tight public purse and potential fear of undermining the Bank of England’s efforts to curb inflation, a 1% cut seems more likely, with even this estimated to cost £6bn.

‘Another option for the Chancellor is to increase income tax thresholds – currently frozen until 2028. Despite the recent 2% cut to national insurance contributions, the freezing of the thresholds means many will still see an increase in their overall tax burden.

‘This fiscal drag effect has paid well for the Treasury, and could be costly to relax. The Resolution Foundation predicts annual receipts will be around £40bn higher in 2027-28 than expected in March as a result of frozen thresholds.’

The frozen thresholds are not only limited to income tax, with the VAT limit of £85,000 unchanged for seven years, while inheritance tax has kicked in at £325,000 since 2009.

Robert Marchant, partner and head of tax at Crowe, said: ‘The mood music from government is that the Conservative party want to reduce the tax burden when it’s at an all-time high.

‘This is tempered by the less desirable option of increasing public borrowing in order to fund tax cuts. As the UK’s economic outlook continues to weaken, the Chancellor has very limited wiggle-room and may look to reduce public spending to deliver these cuts that he and the rest of the party are keen to offer ahead of a general election sometime this year. This is a controversial but short-term approach for political gain and one which an incoming government may opt to reverse.

‘Our first recommendation is reducing ‘red tape’. The fiscal drag caused by people and businesses paying a higher tax rate following the Autumn Statement last year acts as a disincentive for growth as the tax regime tends to become more onerous as more organisations are subject to rules designed for larger entities, when their activities have not significantly changed.

‘Another area hampering growth is how VAT registration thresholds act as a cliff edge for some small businesses, preventing them from expanding as they actively restrict turnover to remain beneath the compulsory registration threshold of £85,000.’