One in five taxpayers will pay 40% tax

The five-year freeze on thresholds will drag 2.5 million more taxpayers into higher rate income tax by 2027.

Sara White, Editor, Accountancy Daily

The number of people paying income tax at 40% or above will reach 7.8m by 2027-28, nearly four times higher than during the 1990s when only the wealthiest earners were caught by higher rates of tax, showed analysis by the Institute for Fiscal Studies (IFS).

For the 40% rate to impact the same fraction of people as it did in 1991, the higher rate threshold would have to be nearly £100,000 in 2027-28 – almost double the current £50,270.

In the 1990s no nurses and just one in 16 teachers paid higher rate tax, but by 2027-28 more than one in eight nurses and one in four teachers are set to be higher rate taxpayers, the IFS said. Now an increasing number of nurses, teachers and electricians are being dragged into the higher rate, while nearly half of lawyers will face higher tax bills.

The 40% tax rate kicks in for earnings above £50,270 and this rises to 45% for income over £125,140, with higher rates in Scotland of 42% and 47% respectively.

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 then chancellor Geoffrey Howe doubled VAT to 15% in 1979.

Blick Rothenberg CEO Nimesh Shah said: ‘In 2010 the personal allowance was £6,475 and the higher rate threshold was £43,875; in 2023, the personal allowance is £12,570 and the higher rate threshold is £50,270 - an increase of just under £6,400, or put another way, around £500 a year.

‘Jeremy Hunt committed to keeping the higher rate threshold at this level until 2028 raising over £25bn for HM Treasury.

‘The effect of frozen allowances is the equivalent of increasing basic rate income tax to 23.5% - therefore any pre-election tax cutting measures from the government would need to be dramatic to restore any sort of parity.’

In 1991-92 3.5% of UK adults (1.6m) paid the 40% higher rate of income tax. By 2022-23 11% (6.1m) were paying higher rates, with that figure set to reach 14% (7.8m) by 2027-28.

The IFS analysis showed that 3.1% of adults (1.7m) will face marginal tax rates of either 45% or 60%. That is almost as large a share as paid the 40% higher rate at the start of the 1990s.

‘The fourfold increase in the share of adults facing a 60% marginal tax rate between 2010-11 and 2023-24 is part of an unwelcome proliferation in marginal income tax rate ‘spikes’ for those with high incomes that has occurred over the last decade,’ IFS said.

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 1.7m people will be paying marginal rates of 60% and 45% in the next few years, this represents a fundamental and profound change to the nature and structure of our income tax system.

‘The freeze to thresholds is supercharging that process, pulling an additional 2.5m people into paying rates of 40% or more by 2027-28.

‘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.’

The withdrawal of child benefit for those earning above £50,000 and of the free childcare entitlement for those earning above £100,000 both create marginal tax rates well in excess of 40% for those affected and risk generating distortions and inefficiencies in taxpayer behaviour, the IFS warned.