The UK’s biggest Budget fear is an increase in income tax, an Opinion poll run for Hargreaves Lansdown revealed last month and, unfortunately, “your biggest tax fear is about to come true”, according to Sarah Coles, head of personal finance at the firm.
To do this, the government is expected to leave current allowances and thresholds untouched, thereby raising income tax by stealth.
“It means every inflation-linked pay rise will push more people into paying more tax, and more into paying higher rates,” she explained.
This policy has already pulled more than 8.3 million people into paying higher or additional rate tax, up over 45% since the start of the freeze in 2021.
But fears go further than this, because the most common worry is that income tax itself will rise. While this was ruled out in the election manifesto, chancellor Rachel Reeves refused in her speech this morning to reinstate the pledge to leave VAT, National Insurance and income tax untouched, stating “honesty is more important than manifesto promises”.
Reeves is now reportedly considering an increase in income tax by 1 percentage point across the board.
For someone earning £35,000 a year, roughly the average income of a UK adult, an extra 1% on income tax would cause their annual bill rise from £4,486 to £4,710, as calculated by Rachel Vahey, head of public policy at AJ Bell. This increase is well in excess of £200 and could yield HMRC a cumulative total of £8.2bn.
Other key considerations include: a 1 percentage point increase in the top income tax rate, which would raise £0.2bn; a 5 percentage points rate rise, which could contribute £1bn, forming part of a £9 billion package; and not indexing income tax bands, which could raise an additional £7bn to £10bn, depending on inflation.
An income-tax hike would add to the drag on households’ real incomes from high inflation and slowing pay growth, said Andrew Wishart, senior UK economist at Berenberg.
“As these factors weigh on demand, inflation will likely ease. If so, this will allow the Bank of England to cut interest rates by 25 basis points at least twice next year to 3.5%.”
Michael Browne, global investment strategist at the Franklin Templeton institute, said gilts are likely to rally but sterling may depreciate due to anticipated rate cuts from the Bank of England.
“Historically, falling interest rates benefit the FTSE 250, and a weak sterling could boost the FTSE 100, given its significant overseas sales,” he said.
“The situation mirrors consumers’ dilemmas about booking future holidays and purchasing foreign currency. The question remains whether companies are reducing prices due to weak employment prospects or tax-induced consumer pinch.”
Reeves is navigating a “challenging economic landscape with limited flexibility” and aiming for “short-term economic restraint in anticipation of a recovery in 2027”, Browne concluded.