The freezing of personal tax thresholds in the UK until at least April 2026 compounded with faster than expected wage growth is set to bring 2.5 million people into the higher rate bracket, research by advisory firm LCP found.
According to HM Revenue & Customs (HMRC) figures in June 2021, as of 2019-20 there were 4.3 million people paying income tax at the higher rate of 40% or the additional rate of 45%.
The taxman also estimated a 300,000 increase for the 2021-22 financial year, with 4.6 million higher rate taxpayers.
But LCP partner and former pension minister Steve Webb said that, at the time, HMRC only had access to wage growth estimates by the Office for Budget Responsibility (OBR) published in March 2021.
Since then, the OBR has “dramatically increased its estimates of wage growth to date and into the future”, he said.
As a result, the government body now believes that wages and salaries grew by 2.6% in 2020-21 and 7.5% in 2021-22 – a significant increase from the 0.9% and 2% it previously forecast.
‘Ultimate stealth tax’
By comparing the data with HMRC statistics, Webb estimates that such a staggering difference in taxable income forecasts is likely to bring the number of higher rate taxpayers to 5.2m for the 2021-22 financial year.
By 2024-25, “it seems likely that up to 2.5 million people could be brought into higher rate tax” since the general election in 2019, he added.
This means that more than one-in-five taxpayers could be paying at the higher rate in 2024-25 compared with fewer than 10% in 2010-11.
Tax relief
But Webb said the “silver lining” is that those who will end up in the higher band will be able to claim higher tax relief on their pension contributions.
He continued: “HMRC admitted last year that it thought over a third of a million extra people would be brought into higher rate tax in the first two years of this parliament. But that was before the surge in wage levels as the economy has bounced back from the pandemic.
“As a result, it is likely to be closer to a million people who have been brought into higher rate tax so far. In addition, three more years of relatively rapid wage growth coupled with a freeze on tax thresholds could bring a further 1.5 million people into higher rate tax by the time of the next election, making a total of 2.5 million more over the whole parliament.
“There is no doubt that freezing tax allowances and thresholds is the ultimate stealth tax. No minister has to announce a rise in tax rates, but tens of millions of people pay more tax, and millions of those will even be dragged into higher tax bands purely because of wage inflation.
“This is certainly not a transparent way of raising extra tax revenue. However, it does mean that millions of people now have a much bigger incentive to put more money into their pensions, potentially enjoying double the rate of tax relief on any contributions.”
