Tax thresholds, unchanged since the 1980s - their current values considering inflation and economic growth
In a move that has been criticised by many, the income tax threshold freeze is set to continue until 2028/29, a decision that has far-reaching implications for taxpayers across the UK. This freeze, coupled with the fact that certain allowances and thresholds have not been adjusted for inflation, has led to an increase in the real tax burden for many.
One such allowance that has been frozen since April 1981 is the Inheritance Tax (IHT) annual gifting allowance, which, if adjusted for inflation, should be £11,529 today. Similarly, the income tax additional rate threshold has been frozen at £125,140 since April 2010, a figure that, adjusted for inflation, should be £231,000 today.
The 60% income tax trap, which catches those whose income exceeds £100,000, has been affected by these frozen thresholds. In today's terms, taking inflation into account, the tax threshold could have moved from £100,000 to just over £150,000.
These frozen thresholds have resulted in 3.5 million more individuals being pulled into the higher-rate tax band of 40% by 2028/29, according to the Office for Budget Responsibility.
In contrast, the U.S. federal tax thresholds, such as the standard deduction, personal exemptions, and tax brackets, have been routinely adjusted for inflation since 1985 as a standard practice. However, post-2017’s Tax Cuts and Jobs Act, changes have slowed the adjustment of tax brackets, effectively causing them to rise more slowly with inflation and pushing taxpayers into higher tax brackets faster over time.
In the UK, between March 2021 and November 2022, almost all main allowances and thresholds in income tax and national insurance contributions were frozen, effectively not adjusting for inflation during that time.
As we approach 2028-29, personal tax thresholds are expected to be uprated in line with inflation once again. However, several other thresholds remain frozen. The savings allowance for basic rate taxpayers has been frozen at £1,000 since April 2016, but if adjusted for inflation, it should be £1,368 today. The income tax higher rate threshold has been frozen at £50,270 since April 2021, a figure that, adjusted for inflation, should be £62,059 today.
The residence nil rate band, which increases the tax-free threshold for many homeowners, has not been increased for five years. Similarly, the income tax basic rate threshold has been frozen at £12,570 since April 2021, a figure that, adjusted for inflation, should be £15,517 today.
The savings allowance for higher rate taxpayers has been frozen at £500 since April 2016, a figure that, adjusted for inflation, should be £684 today. The nil-rate inheritance tax band has been frozen at £325,000 since 2009, leading to increasing yearly inheritance tax receipts as rising asset prices tip more estates into IHT territory.
Savers who move up to the higher-rate tax bracket at 40% will see their personal savings allowance (PSA) halved, from £1,000 worth of savings interest tax-free each year to just £500. As of now, there are over 8.3 million higher and additional rate taxpayers paying more than the basic income tax rate of 20%.
The freeze on tax thresholds has been met with criticism, with Chancellor Rachel Reeves stating that extending the income tax threshold freeze until 2030 would boost government coffers by billions of pounds, but also noted that it would hurt working people and go against Labour's manifesto commitments. Furthermore, the residence nil rate band, which increases the tax-free threshold for many homeowners, is not available to those who do not leave their family home to direct descendants, such as children and grandchildren, a provision that penalises childless couples.
- The savings allowance for basic rate taxpayers, currently frozen at £1,000 since April 2016, if adjusted for inflation, should be £1,368 today, highlighting a potential gap in personal finance for many savers.
- Despite the income tax basic rate threshold being frozen at £12,570 since April 2021, if adjusted for inflation, it should be £15,517 today, raising concerns about the impact on citizens' financial situations and personal-finance management.
- Pensions and other investments that provide dividends can become a significant part of personal finance, but the freeze on tax thresholds has led to an increase in the real tax burden for many, potentially impacting their long-term savings and retirement plans.
