Why you’re set to pay thousands more in income tax in the next four years

Workers could lose thousands of pounds more from their incomes over the next few years – unless Chancellor John Healey acts to reverse his predecessor’s “stealth tax” rule. The personal allowance – the amount people can earn before paying income tax – has been frozen at £12,570 since 2021, and the freeze was extended to 2031 by former chancellor Rachel Reeves at last year’s Budget. The £50,270 threshold at which people start paying the higher 40 per cent rate of income tax was also frozen, while the additional rate threshold at which you start paying the 45 per cent rate has been frozen since 2023, after previously being reduced to £125,140. Shorts This creates a so-called “stealth tax” as salaries grow to keep up with inflation, causing workers to pay more in income tax and national insurance (NI) over time. This will continue unless a change is made in the Budget on 28 October. Calculations by wealth manager Quilter suggest that an average earner on a salary of £40,000 could cumulatively pay an extra £911 over the next four years if the thresholds remain frozen, while higher earners will end up paying more than £4,000. Andy Burnham has come under pressure in recent months to increase the allowance from £12,570. It seems unlikely this would happen, but some in Westminster believe there could be a surprise hike at Wednesday’s Budget. If he did, it would answer the question of the new full state pension, which is set to rise above the personal allowance for the first time next April. Ministers have said those who rely solely on the state pension won’t need to pay income tax. Here’s how a continued freeze could affect you – and the income tax you pay. How your tax bill will be affected Under current Treasury plans, most workers will end up paying extra tax in the next few years. Quilter’s calculations for how much extra income tax you will pay, depending on your starting salary – and if Reeves’ “stealth tax” remains in place – are below. Experts said the extra tax costs are an example of what is known as “fiscal drag”. This is when rising wages or inflation push taxpayers into a higher tax bracket, while the tax thresholds remain unchanged. “Labour made a clear manifesto commitment not to raise taxes on working people, but the reality is that by leaving this policy untouched, many working people are paying significantly more tax. You do not need to put income tax rates up when fiscal drag is doing so much of the heavy lifting for you,” said Shaun Moore, tax and financial planning expert at Quilter. “Frozen thresholds might be very useful for the Treasury, but they are becoming increasingly difficult to justify. The longer the freeze goes on, the more people are dragged into higher rates of tax and the more these strange cliff edges and distortions start to bite.” The biggest rises in tax are seen for those on salaries of around £100,000. This is because every extra pound these people earn is effectively taxed at 60 per cent until they earn £125,140. Once your income exceeds £100,000, your tax-free personal allowance begins to reduce by £1 for every £2 you earn. When you earn an extra £2 in this bracket, you pay 40 per cent higher rate income tax on it (costing you 80p), and you lose £1 of your tax-free allowance. Total tax and lost allowance equal £1.20 out of every £2 earned. Quilter’s assumptions compare how much extra tax someone will pay if this threshold remains at £100,000 – as it has done since 2010 – compared to if it were increased by inflation annually from 2027. Will Burnham change things? Experts say it is unlikely that Burnham will take action to increase the tax thresholds at the Budget, largely because of the cost. HMRC’s own figures suggest that raising the personal allowance by even £100 would cost around £1.2bn next tax year, and this gap would likely have to be filled by other tax rises, spending costs, or extra borrowing. The Government has a small amount of headroom – a buffer before it misses its own self-imposed financial rules. In short, these state that the Treasury must balance its day-to-day Budget so that spending is funded entirely by tax revenues, rather than borrowing. But the fiscal headroom – which was forecast to be £23.6bn in March – is already expected to fall at this Budget, with some experts predicting it will be as low as £12bn on 28 October. This is largely because of spending commitments the Government has made – such as bus fare caps – and higher borrowing costs. Nimesh Shah, CEO of tax firm Blick Rothenberg, explained: “Freezing the thresholds is such a big cash cow that the Government don’t want to turn this tap off. “People don’t understand it and don’t realise all the extra tax they are paying, so it’s a winner for the Government. There is no reason for the Government to do anything here.”