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The chancellor has some tough decisions ahead. There is a gap between tax revenues and the government’s spending plans of about £20 billion. Although that’s less than some previous forecasts of £30 billion or more, it still means that tax rises are a near-certainty.
Where will these tax rises come from? With an income tax rate rise now ruled out, we explain the main areas where taxes could rise in the UK Budget 2025.
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There had been rumours the Labour government would break a manifesto pledge and increase income tax by 2p in the pound to raise much-needed funds. But an income tax rate rise is now expected to be off the cards, while the main rates of national insurance and VAT are also likely to be left untouched.
The change of heart seems to have come after a backlash from Labour party colleagues, and after the latest forecast from the Office for Budget Responsibility (OBR) put the government’s black hole closer to £20 billion – better than the previously reported £30 billion.
The personal allowance – the amount you can earn before you start paying income tax – is £12,570. It is currently frozen until April 2028. Christine Cairns, a tax partner at PwC, says she expects the Treasury to extend this freeze to April 2030.
“The freeze on personal tax thresholds until April 2028, rather than indexed to follow inflation, naturally means many working people are paying more tax sooner than they otherwise would. An extension to the freeze to 2030 would likely raise over £10 billion over the two additional years,” she says.
Shaun Moore, a tax and financial planning specialist at Quilter, says that for someone earning £44,000 today, extending the freeze increases their tax bill by £843 over the next four years. For a worker earning £40,000 today, the freeze adds £321 over the period to 2030.
“Income tax thresholds are meant to provide protection against fiscal drag not used as a tool to raise ever more revenue. Freezing them for years has already brought record numbers of people into higher rate tax,” he says.
A freeze to the thresholds at which the tax rates apply are expected to raise £39 billion in 2029/30, says the Institute for Fiscal Studies (IFS).
It would take the total number of income tax payers at 42.1 million – 5.1 million higher than if there had been no freezes since 2021.
The freezes mean the full new state pension is set to exceed the personal allowance in 2027/28, meaning more pensioners will pay income tax. In 2022/23, just under half of people receiving the full new state pension paid income tax, but that will rise to 100% in 2027/28.
Scotland has its own income tax bands and thresholds, but any changes to the rates or thresholds in the rest of the UK are likely to be reflected in the funding that Scotland gets from the UK government. So a rise in UK income tax revenues would mean less funding for the Scottish government, which increases pressure on the Scottish government to match the rise, or raise taxes elsewhere if it can, or cut its spending plans.
The UK income tax thresholds are also the ones used for various taxes and allowances everywhere in the UK (including Scotland). This includes the personal savings allowance and capital gains tax.
Some people think it’s possible the Treasury could lower the earnings threshold at which people start paying 40% income tax.
Currently the rate of income tax rises from 20% to 40% for earnings above £50,270 (in England, Wales and Northern Ireland), with 45% additional tax for earnings over £125,140.
Some reports suggest the Treasury is considering lowering the higher-rate tax earnings threshold to £45,000, and potentially freezing it at this level for the next few years. But other sources have denied this, and overall a freeze in existing thresholds seems a more likely option.
Moore says: “Actively cutting the thresholds would be a far more aggressive step and risks pulling millions more people into paying higher rate tax almost overnight. If the government then extends the freeze into future years, it pours fuel on the fire.”
The Treasury hopes to raise £2 billion by making changes to ‘salary sacrifice’ schemes which allow employees to ‘sacrifice’ some of their salary by putting it into their pension instead. It means that they don’t pay national insurance or income tax on those contributions.
According to The Times and other outlets, Rachel Reeves is considering capping salary sacrifice pension contributions at £2,000 a year. Contributions above this would have to pay national insurance, in the same way as on take-home pay. This would likely be at 8% for basic rate taxpayers or 2% for higher-rate taxpayers. (If you’re in Scotland the rates you pay are based on the UK income tax thresholds, not the Scottish ones.)
While you would still benefit from income tax relief, the loss of the national insurance saving reduces the overall efficiency of the scheme.
Employers would also face a higher tax bill if a cap is introduced as they would need to pay employer national insurance at a rate of 15% on contributions above the cap.
Only a minority of pension schemes use salary sacrifice – around a third of private sector employees and almost 10% of public sector workers, according to the Society of Pension Professionals (SPP). So most pension schemes would be unaffected by this change. Despite that, salary sacrifice arrangements cost the government £1.2 billion in employees and £2.9 billion in employer contributions.
Pension campaigners are largely against the move, saying people already don’t save enough into their pensions and reducing the incentive for people to pay into a workplace pension could make that worse.
Steve Hitchiner, chair of SPP’s tax group, says changing salary sacrifice arrangements would lead to a reduction in take-home pay for millions of employees who are saving into a workplace pension, with the greatest impact for those earning less than £50,284 a year.
“It would also represent another sizeable cost to employers, despite the chancellor’s public commitment against this, and would undermine the critical role that employers play in supporting and promoting good quality pension saving vehicles.”
There is also the risk that employers might react by reducing their pension contributions, which would reduce the revenue benefit to the Treasury of the change.
High-value homes are also in the chancellor’s sights.
The government is considering a council tax revaluation for homes across bands F, G and H – affecting about 1 in 10 homes or 2.4 million properties – according to the Telegraph.
A new separate surcharge would then be applied on 300,000 of the most valuable properties, raising about £600 million for the Treasury.
Some people are calling it a ‘mansion tax’ as the surcharge would likely affect those with homes valued at more than £2 million.
Property portal Rightmove says speculation about potential new property taxes has already caused uncertainty in the housing market in recent months, particularly at the top end. Sales agreed for homes worth more than £2 million are down 13% year-on-year, its data suggests.
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