Chancellor Sunak stuck to the original Conservative Manifesto pledge of not raising VAT, NICs or income tax rates in this Budget. But they are going to be frozen, after a small rise in April 2021, until 2026.
What difference will that mean to you?
What did the Budget actually say about income tax thresholds?
The income tax thresholds will rise when we start the new financial year on 6th April 2021.
- Personal Allowance: £12,570, from £12,500. Anything you earn under that figure is tax free.
- Basic rate: 20% on anything you earn over £12,570
- Higher rate: 40% on income over £50,270, from £50,000
How will freezing the Personal Allowances and income tax thresholds cost me money?
It’s this freeze that’s causing consternation, as some see it as a tax increase without the government having to say it’s a tax increase.
As Interactive Investor’s head of pensions and savings, Becky O’Connor told the Guardian: “Freezing allowances is a back-handed way of raising taxes, as wage inflation and asset price inflation increase the number of people pushed over the thresholds at which they have to pay more tax. Frozen allowances and thresholds have a habit of remaining fixed for many years, dragging more people into tax charges over time.”
Basically, if your wages go up over the next four years, you can end up paying more in income tax. If the band thresholds don’t change, then you’re automatically taken into the next bracket. This even has a proper name – ‘fiscal drag’.
People previously not paying any income tax are tipped over the Personal Allowance threshold and start paying 20% tax on everything over the £12,570. Basic rate taxpayers find themselves with part of their salary in the 40% tax rate on income over £50,270. This Higher Rate of tax will also be chargeable on these taxpayers’ investment income and private healthcare. So they could be paying a lot more tax on the entirety of their hard-earned income.
So the Chancellor doesn’t break the Conservative Manifesto pledge to not increase NICs, income tax or VAT, but does make more taxpayers by freezing the Personal Allowance and income tax brackets.
How many people will this affect?
The Institute for Fiscal Studies’ report on the Budget predicts that this will take an additional 3% from under the tax free Personal Allowance into the Basic Rate tax bracket by 2026. It also expects to see the total Higher Rate taxpayers to become 11% by 2026, from the current 8.7%, as a result of this policy.
The Office of Budget Responsibility analysis also sees significant rises, saying that 1.3 million more people will start paying income tax and 1 million more Higher Rate taxpayers will be created. Those 2.3 million taxpayers will generate approximately £8 billion extra tax into the Treasury.
Whether or not you’re affected depends on your income. Earning a higher salary may actually mean you end up losing out more in tax. It’s something to keep in mind and reassess as your circumstances change over the next four years.