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Speculation is mounting that the government will increase income tax in the upcoming Budget, in a move that could hit retired people harder.
The government committed not to increase key taxes for ‘working people’ in its 2024 manifesto. That means income tax, national insurance and VAT. But in recent days, both the prime minister and chancellor have refused to rule out breaching this pledge.
We explain what’s been rumoured and the impact the proposals could have on your finances.
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The ‘black hole’ that the chancellor is attempting to plug is now estimated to be over £30 billion. Despite tax increases in the Budget last year, with increases to national insurance for employers as well as next year’s rise to IHT on pensions, the public finances have continued to get worse, meaning further tax hikes now look inevitable.
As Ian Cook, chartered financial planner at Quilter Cheviot says: “While Rachel Reeves has [previously] said she won’t raise income tax, NI or VAT, the fiscal pressures she faces are immense. If she does decide that revenue needs to be raised, a straightforward, wholesale change to income tax might be more palatable than a raft of smaller, piecemeal tweaks to other areas of the tax system, such as pensions.”
There are a number of ways that the government could increase revenues from income tax.
Here we take a closer look at some of the options that are being discussed:
One measure that has gained a lot of traction is the ‘two up, two down’ income tax and national insurance (NI) shift, a move that could bring the Treasury around £6 billion a year.
It involves increasing the rate of income tax by 2p and reducing the rate of national insurance for employees by 2p as well.
The proposal has been made by the left-leaning think tank the Resolution Foundation. Its former chief executive, Torsten Bell, is now the minister for pensions and a key adviser to the chancellor.
Although it would be cost-neutral for most workers (except those in Scotland), as the NI reduction offsets the increase in income tax, people that don’t pay national insurance on their income, such as retirees and landlords, would see their tax bills rise.
According to calculations from AJ Bell, this would mean a pensioner with an income of £35,000 a year, would pay a further £448.60 in tax as a result. Pensioners with an income of £65,000, meanwhile, would see their tax bill soar by £1,048.60 a year.
Commenting on the proposal, Tom Selby, director of public policy at AJ Bell, said: “While hitting pensioners in the pocket will clearly be unpopular – particularly in the wake of the winter fuel payment fiasco – it may be viewed as the least bad option to raise a chunk of the tens of billions of pounds the chancellor needs to balance the books.”
Natasha Etherton, financial planning director at Evelyn Partners, said: “The chancellor may think this is levelling the playing field, but most over 66s on fixed incomes and already struggling with years of elevated inflation and a soaring cost of living, are likely to disagree.”
“For many retirees the ability to accumulate more wealth is behind them and current favourable interest rates on any savings will not make up for the extra tax burden, particularly after inflation and given that savings interest allowances [the personal savings allowance] are also frozen.”
But she stressed the proposal is not a ‘done deal’. “This is only one among many floated ideas on where tax rises might be implemented at the end of November, there is, as yet, no reason to give it real credence.”
In Scotland, income tax rates are set by the Scottish government. Rates of national insurance are the same across the UK. So this change could potentially mean that those in Scotland pay less tax than they do currently.
However, the funding mechanism between the UK and Scotland means that the Scottish government would receive less funding if income tax rates are put up. So it would have to raise taxes somewhere, or reduce spending.
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Another option is to increase income tax rates without reducing national insurance. Although this would affect nearly all taxpayers in England, Wales and Northern Ireland, it could still feel particularly difficult for pensioners living on fixed incomes.
The National Institute of Economic and Social Research, an independent economic thinktank, has suggested that increasing the basic and higher rate tax rates by 3p would be less damaging to the economy than making a series of smaller changes to other taxes. But a 3p increase to income tax seems politically unlikely.
One possibility that has been modelled by HMRC is adding 1p to the basic rate of tax only. Another is keeping basic rate tax at 20% and adding 1p to the higher and additional rates of tax.
The most lucrative option for the government would be to add 1p to basic rate tax as that’s paid by the largest number of people. According to HMRC calculations, it would raise £6.9 billion more in 2026/7, £8.25 billion in 2027/8 and £8.2 billion in 2028/9.
Sarah Coles, head of personal finance at Hargreaves Lansdown, said: “The cost would vary with earnings. If you earned £35,000 a year, an extra 1p on basic rate tax would add £224 to your tax bill each year. If you earned £55,000, it would cost you an extra £377.”
Increasing higher and additional rates of tax might be more appealing for the chancellor, as those on lower incomes wouldn’t be affected. However, it wouldn’t be the money spinner that Rachel Reeves needs.
The HMRC analysis shows that adding 1p on higher rate income tax could raise £1.6 billion more in 2026/7, £2.15 billion in 2027/28 and £2.1 billion in 2028/9. A rise in additional rate tax would raise even less – £45 million in 2026/7, £265 million in 2027/28 and £230 million in 2028/29.
“You have to ask whether the government would want to go back on a manifesto promise in order to raise these sorts of sums,” Coles adds.
Alternatively, the government could go ‘full throttle’ and add 1p to all rates of income tax. The appeal of this approach is that higher earners would pay a larger share. Coles explains: “If an extra 1p was added at every level, someone earning £35,000 a year would see the same change as just a basic rate tax hike – at £224. Meanwhile if you earned £55,000, it would cost you an extra £424 and if you earned £75,000, it would cost you £624 more.”
Those in Scotland wouldn’t be affected by these changes unless the Scottish government implements its own income tax rises.
Even if income tax rates aren’t increased in the Budget, the tax burden on retirees is still likely to grow. Income tax thresholds have been frozen until 2028, meaning more people on lower incomes are breaching the £12,570 personal allowance and starting to pay tax, while more ‘comfortable’ retirees are being dragged into the higher rate tax bracket. According to LCP, there are now one million pensioners paying tax at the higher rate (40%) or above.
Cook says: “For retirees, the direction of travel is clear: more people will be paying tax in later life, even if headline rates stay the same.”
Etherton says it’s important to plan, not panic. “We wouldn’t suggest making big changes ahead of the Budget,” but “it is important that retirees are using all their tax allowances and exemptions (such as those for ISAs and savings interest), especially in the case of couples where it might be possible to switch and allocate savings and investments tax-efficiently, and even adjust income levels to avoid paying too much income tax overall.”
She adds: “It’s also vital that those in retirement are accessing any benefits they may be eligible for.”
