Will the Tax Threshold Freeze Impact Your Take-Home Pay?

Wages in the UK have been rising at a pace that outstrips inflation for over two and a half years, presenting a unique situation for taxpayers. However, due to frozen tax thresholds, many individuals may find themselves paying higher taxes on their increasing salaries. This article explores the implications of these frozen thresholds, how they affect different income brackets, and the broader impact on UK households and the economy.

Last updated: 01 October 2023 (BST)

What’s happening now

The UK government has extended the freeze on income tax thresholds until 2031, which means that as wages rise, many taxpayers will face increased tax liabilities without any adjustment in the thresholds. This freeze, initially implemented in 2022 under former Chancellor Rishi Sunak, was intended as a measure to increase government revenue without overtly raising tax rates. The current Chancellor, Rachel Reeves, has confirmed this extension in the recent Autumn Budget.

This situation is particularly concerning as average wages have been consistently rising faster than inflation since July 2023. The latest figures from the Office for National Statistics (ONS) indicated that weekly earnings growth was at an annual rate of 0.8% after adjusting for inflation. Yet, with tax thresholds remaining static, many workers will feel the pinch of a so-called "stealth tax," where increased earnings lead to a higher tax burden without any corresponding increase in take-home pay.

Key takeaways

Wages have been rising faster than inflation for over two and a half years.
Frozen tax thresholds until 2031 will lead to higher tax bills for many UK workers.
The average worker earning £39,000 will pay an additional £465 in tax by 2030-31.
Middle-income households are disproportionately affected by the freeze.
More than 5 million additional people will be paying the basic rate of income tax by 2030-31 due to the freeze.

Timeline: how we got here

The freeze on tax thresholds has evolved through several stages since its inception:

March 2022: Former Chancellor Rishi Sunak implements a freeze on income tax thresholds until 2026.
November 2022: The freeze is extended for an additional two years until 2028.
November 2023: Chancellor Rachel Reeves announces the extension of the freeze until 2031.

What’s new vs what’s known

New today/this week

The key development is the announcement of the extended freeze on tax thresholds, which will now remain in place until 2031. This decision has been met with criticism from various economic analysts who argue that it disproportionately affects lower and middle-income earners.

What was already established

Prior to this latest announcement, it was known that tax thresholds had been frozen since 2022, leading to increased tax liabilities as wages rose. The previous analysis indicated that this freeze would lead to millions more individuals entering higher tax brackets without any adjustment to the thresholds.

Impact for the UK

Consumers and households

For average consumers, the freeze in tax thresholds means that as salaries rise, the amount taken home can diminish due to increased tax liabilities. For instance, an individual earning £39,000 could see an additional £465 in tax by 2030-31 due to the freeze. This has significant implications for household budgets, potentially leading to reduced disposable income for families across the UK.

Businesses and jobs

For businesses, the impact of frozen tax thresholds can be twofold. On one hand, higher salaries may lead to increased consumer spending, which can benefit businesses. On the other hand, as employees move into higher tax brackets, they may have less disposable income to spend, affecting overall demand for goods and services. Businesses may need to consider these dynamics when planning for growth and hiring.

Policy and regulation

The extension of the tax threshold freeze is part of a broader strategy by the UK government to manage public finances, especially in the wake of increasing expenditures on public services. The government’s analysis suggests that while lower-income households may see some benefits, the overall effect will see many in the middle-income bracket facing higher tax bills. Upcoming consultations and potential policy adjustments will be essential to watch, as they may influence how these measures will play out in the coming years.

Numbers that matter

£12,570: The personal allowance threshold where no income tax is paid.
20%: The basic rate of income tax applied to earnings between £12,571 and £50,270.
40%: The higher rate of income tax on earnings between £50,271 and £125,140.
5.2 million: The estimated increase in individuals paying the basic rate of income tax by 2030-31 due to the frozen thresholds.
£56 billion: Estimated revenue generated by frozen income tax thresholds by 2030-31.

Definitions and jargon buster

Personal Allowance: The amount of income you can earn each year without having to pay income tax, currently set at £12,570.
Stealth Tax: A term used to describe tax increases that occur without direct changes to tax rates, often due to inflation adjustments or frozen thresholds.
Office for Budget Responsibility (OBR): An independent body that provides economic forecasts and analysis to the UK government.

How to think about the next steps

Near term (0–4 weeks)

In the immediate term, workers should assess their current tax situation and consider how their income may change over the next few years. It may be beneficial to consult tax advisors for personalised guidance.

Medium term (1–6 months)

As the government continues its fiscal policies, monitoring any changes in public spending and tax policy will be crucial. Individuals should prepare for potential adjustments to their financial strategies to mitigate the impact of tax increases.

Signals to watch

Changes in government fiscal policies announced in future budgets.
Updates from the OBR regarding economic forecasts and tax projections.
Public sentiment and responses to the tax policy changes, which may influence future elections.

Practical guidance

Do

Review your payslip and understand how much tax you are currently paying.
Consider tax-efficient savings options such as ISAs or pension contributions.
Stay informed about changes to tax policies and thresholds in future budgets.

Don’t

Ignore changes in your tax bill as your salary increases.
Assume that tax thresholds will automatically adjust; they are frozen until 2031.
Neglect to seek professional tax advice if your earnings change significantly.

Checklist

Check your current salary against tax thresholds.
Calculate your potential tax liability for the next few years.
Explore available tax reliefs that may apply to your situation.
Monitor government announcements regarding tax policy changes.
Consider financial planning to optimise your income post-tax.

Risks, caveats, and uncertainties

While the current analysis provides a clear outlook based on existing data, uncertainties remain regarding future economic conditions, inflation rates, and potential changes in government policy. The impact of frozen tax thresholds will vary based on individual circumstances, and it is prudent to consider personal financial strategies in light of these factors.

Bottom line

The freezing of tax thresholds until 2031 poses significant implications for UK taxpayers, particularly as wages continue to rise. The additional tax burden could strain household budgets, especially for middle-income earners. Being informed and proactive about personal finances is crucial during this period of economic adjustment.

FAQs

How do frozen tax thresholds affect my salary?

Frozen tax thresholds mean that as your salary increases, you may pay more tax without any adjustment in the income tax brackets. This results in a higher effective tax rate on your earnings.

What are the current tax thresholds in the UK?

The current tax thresholds are: no income tax on the first £12,570 (personal allowance), 20% on income from £12,571 to £50,270, 40% from £50,271 to £125,140, and 45% on income above £125,140.

What should I do if I expect my salary to rise?

If you expect your salary to rise, it’s wise to review your tax situation and consider seeking professional advice to understand how the frozen thresholds will impact your take-home pay.