The number of people paying income tax at 40 per cent or above will reach 7.8mn by 2027 to 2028, according to research by the lnstitute for Fiscal Studies (IFS).
In a report titled, A deepening freeze: more adults than ever are paying higher-rate tax, the IFS revealed that one in five taxpayers and one in seven of the adult population, will be paying the higher rate tax.
This is near-quadrupling of the share of adults paying higher rates since the early 1990s.
By 2027 to 2028, more than one in eight nurses and one in four teachers are set to be higher-rate taxpayers.
IFS said this represents a “seismic shift” compared to the 1990s when no nurses and just one in 16 teachers paid higher-rate tax.
The six-year freeze to income tax allowances and thresholds which started in April last year is now set to become the single biggest tax-raising measure since Geoffrey Howe doubled VAT in 1979, according to the IFS.
It will play a major role in expanding the reach of higher rates over the coming years.
The freeze will also compound challenges facing the many workers whose earnings are not keeping up with inflation, the IFS explained.
It said a third of the expected record fall in household incomes this year is likely to be a result of this tax rise.
Isaac Delestre, research economist at IFS, said: “For income tax, the story of the last 30 years has been one of higher-rate tax going from being something reserved for only the very richest, to something that a much larger proportion of adults can expect to encounter.
“Alongside the fact that 1.7mn people will be paying marginal rates of 60 per cent and 45 per cent in the next few years, this represents a fundamental and profound change to the nature and structure of our income tax system.”
Delestre said the freeze to thresholds is “supercharging that process”, pulling an additional 2.5mn more people into paying rates of 40 per cent or more.
“Whether or not the scope of these higher rates should be expanded is a political choice as much as an economic one, but achieving it with a freeze leaves the income tax system hostage to the vagaries of inflation – the higher inflation turns out to be, the bigger impact the freeze will have,” he said.
Other findings
Elsewhere, the report revealed that in 1991 to 1992, 3.5 per cent of UK adults (1.6mn) paid the 40 per cent higher rate of income tax.
By 2022 to 2023, this was 11 per cent (6.1mn) paying higher rates, with that figure set to reach 14 per cent (7.8mn) by 2027 to 2028.
Source: IFS report - A deepening freeze: more adults than ever are paying higher-rate tax
The IFS said for the 40 per cent rate to impact the same fraction of people as it did in 1991, the higher-rate threshold would need to be nearly £100,000 in 2027 to 2028 – almost double its actual level of £50,270.
Laith Khalaf, head of investment analysis at AJ Bell, said: “Millions of people will find themselves with a much bigger tax bill in the coming years, thanks to tax thresholds being frozen or cut.
“Governments often tend to rake in extra coffers from salaries rising faster than tax thresholds, but the current freeze imposed by the Treasury is fiscal drag on steroids.”
Khalaf said the IFS analysis shows that a high proportion of teachers and nurses will be paying higher rate tax by 2028.
Source: IFS report - A deepening freeze: more adults than ever are paying higher-rate tax
“That’s before you throw in the weird and wacky tax rates of over 100 per cent which arise as a result of income tax combined with thresholds for childcare,” he said.
“On top of which the government is also slashing the tax-free allowance for dividends and capital gains tax.”
He explained that all of this adds up to an “unholy cocktail of pressures on households” in the midst of an inflationary crisis.
“Consumers now face a triple whammy of higher taxes, rising prices, and bigger mortgage payments,” he said. “This all limits their ability to spend money, which has a knock on effect on the economy at large, and is a significant contributing factor to flatlining growth.
“While inflation and interest rates are hard to mitigate, consumers are not entirely helpless in the face of rising taxes.
“Judicious use of Isas and pensions can significantly reduce the tax burden. Bank of England figures show that Cash Isas saw their biggest ever March inflow this year, which suggests savers have already got the memo.”
He explained that the costs of the pandemic have not disappeared with the vaccine, and since then the energy support scheme has added to the government debt pile.
The Treasury faces difficult choices between raising taxes and curtailing spending, or abandoning debt targets, which might make things worse if the market’s reaction to the "mini" Budget is anything to go by, he said.
“There is a small glimmer of hope for the Treasury, as borrowing actually came in £13.2bn lower than expected in 2022-23. If that trend continues, the government may yet have a Hail Mary tax giveaway left in the game plan.”
Silver lining
In addition, Dean Butler, managing director for retail at Standard Life, said the combination of frozen allowances and earnings growth is pushing a larger number of people into higher tax bands.
The impact on people’s take-home pay is immediately clear with those breaching each threshold seeing a reduction in the value of each additional pound of earnings, he explained.
“This is of course in addition to the higher interest rate and inflation we're now experiencing which are an added squeeze on household budgets,” he said.
“However, less obvious is the impact on their pension contributions. Personal pension contributions benefit from tax relief at an individual’s highest marginal rate.”
Those earning over £50,271 receive 40 per cent relief on contributions, while those earning over £125,140 benefit from 45 per cent relief.
For those earning between £100,000 and £125,140 the benefit is even greater due to the removal of the personal allowance and those in this group can benefit from an effective rate of relief of 60 per cent.
“It’s not just workers who will be feeling the impact of frozen allowances,” he said.
“Historically relatively few pensioners have been higher rate taxpayers, but with a full state pension effectively using up the majority of pensioners’ personal allowance, those with significant savings or who have benefited from defined benefit pensions will need to look carefully at how much income they take each year, as only the first 25 per cent of pension income is tax free.”
This comes as earlier today (May 16), PensionBee analysis revealed that savers put significantly more money aside for their retirement at the start of 2023 than they did in the latter part of 2022.
Despite persistent levels of high inflation, the average quarterly contribution amount for female savers increased by 58 per cent, from £712 in Q4 2022, to £1,128 in Q1 2023 which incorporates the end of the 2022/23 tax year.
sonia.rach@ft.com
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