A 'hidden' tax hike that was not mentioned in the Labour budget will cost the average worker almost £100 this year. Chancellor John Healey did not refer to the levels of personal tax-free allowances that will apply from April when he unveiled his financial plans this week.
He decided to keep in place a policy 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.
How the freeze affects average wages
That is 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 is just shy of the £100 payment that households in council tax bands A-D will be receiving this winter.
Freezing the allowances means workers are hit by a 'stealth tax' where the taxman takes a greater share of their earnings as wages go up due to inflation. Rachel Reeves continued the policy of freezing the personal allowance until 2030, meaning the thresholds set in 2021 by then chancellor Rishi Sunak will still be in place at the start of the next tax year, when they are traditionally updated.
Fiscal drag and its impact
Freezing the allowance is not 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 freeze has been good news for the Treasury's coffers but bad news for everyone else, due to something called 'fiscal drag'. When people's wages increase but tax thresholds don't, more of their salary is taxable, increasing their tax bill even though 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 £20,500 of the average salary was subject to tax, just under two thirds (62%), resulting in a tax bill of £4,098.
Today, 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.
Projected rise in tax bills
A frozen allowance at that stage would mean £32,100 of the average salary would be taxable, almost three quarters of the total (72%), 10 percentage points higher than when the threshold was first set. It would produce an income tax bill of £6,430, which is £2,331 higher than when the threshold was set, despite income tax rates being unchanged.
Had thresholds been growing in line with wages, 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 they face today.
Maike Currie, VP Personal Finance at PensionBee, commented: "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."
