AJ Bell press comment – 16 November 2022
- Freezing income tax bands until 2027/28 set to cost average earner nearly £2,600
- Biggest squeeze comes for middle earners, with those on a £50,000 salary paying an extra £6,570 in income tax
- Stealth tax on pay is just one of a raft of measures that could be announced at Thursday’s Autumn Statement
- UK now braced for an ‘onslaught of tax rises’ just weeks after being promised tax cuts
A freeze on income tax thresholds until 2027/28 could see average earners hand an extra £2,600 to the taxman, new analysis shows.
The stealth tax rise is tipped to be delivered at Thursday’s Autumn Statement, with Chancellor Jeremy Hunt this week priming everyone to expect a significant increase in tax bills.
AJ Bell’s analysis shows an average earner with a salary of £33,000 in 2021/22 before the income tax threshold freeze began will end up paying £27,378 in income tax if the policy is extended to 2027/28. They would pay just £24,821 if income tax thresholds were linked to inflation over the same period, a difference of 10%.
But the biggest squeeze will come for middle earners on salaries currently just below the higher rate income tax threshold, who will suffer the most as they’re dragged into paying income tax at 40%.
The analysis shows someone earning £50,000 will end up paying 14% more tax over the six year freeze from 2022/23 to 27/28, an increase of more than £6,500 compared to a system in which income tax thresholds matched inflation (see below for further detail).
The income tax threshold freeze is just one of a raft of measures likely to be announced in an effort to boost tax revenues. The Chancellor could also look to raise more tax revenue from: inheritance tax freeze, increasing dividend tax, capital gains tax, scrapping higher-rate pensions tax relief, cutting the annual allowance, reducing or freezing the lifetime allowance, increasing pensions taxation on death, state pension triple-lock, and an Energy company windfall tax.
Commenting on the squeeze on taxpayers, AJ Bell head of personal finance Laura Suter says:
“In a swift about-turn, a nation that was getting tax breaks across the board just weeks ago is now braced for an onslaught of tax rises in this week’s statement. The new chancellor has the unenviable task of filling the Government’s financial black hole, tackling the current cost of living pressures and not deepening the UK’s recession, all while keeping markets on side.
“In a bid to avoid spooking markets again, the Chancellor Jeremy Hunt’s approach seems to be to leak everything so that no-one is surprised when he gets up at the dispatch box. From extending the freeze on tax allowances to a rumoured reduction in the threshold for the highest rate of income tax, the rabbits are already out of the hat.
“However, there appears to be more help for the poorest through the current cost of living crisis, with benefits and the state pension expected to be uprated by inflation, a rise in the national minimum wage tipped and additional cost of living support anticipated. The big reveal will be the details of the new energy support scheme for households, with Truss’ generous offering for all households now ending in April next year. We’re expecting a significantly pared back scheme, targeted at pensioners and those on benefits, but the detail is one thing that hasn’t been tipped ahead of time.”
Revenue raising tax measures the Chancellor could announce at the Autumn Statement
AJ Bell’s experts analyse some of the measures believed to be under consideration:
“The squeezed middle will once again be hit the hardest if the Government’s plans to extend the tax threshold freeze come to pass. The move means that rather than rising with (currently high) inflation, the point at which you start paying tax, and at which the higher rate tax kicks in, will be stuck at their current levels until 2027/28. With wages steadily climbing, it means millions more people will become higher-rate taxpayers and see a larger chunk of their earnings hit with basic rate tax.
“The latest Government figures show there is already expected to be a 50% increase in the number of additional rate taxpayers this year, and a 44% increase in the number of higher-rate payers – extending the freeze from the current 2025/26 to 2027/28 will only fuel these numbers.
“Those earning £50,000, and so hovering just under the current higher-rate threshold, will be hit the hardest, paying £6,570 more in income tax over the entire period of the tax freeze from 2022/23 to 2027/28. That represents a 17% increase in their income tax bill over that period – something many will find difficult to afford. But even those on lower salaries will be paying significantly more tax, with someone on the average UK salary of £33,000 paying almost £2,600 more income tax thanks to the freeze.
“’Fiscal drag’ isn’t a phrase well understood by many among the electorate, and the new Chancellor will be relying on that. Complicated headlines about a stealth tax rise and frozen allowances will be more palatable than a direct hike in income tax rates – and crucially don’t break that 2019 manifesto pledge. But it will likely cost the taxpayer more, assuming wage inflation remains at expected levels.”
|
Salary at start of 2021/22 tax year |
Total tax due with frozen allowances (from 2022/23 to 2027/28) |
Total tax due with inflation-linked allowances (from 2022/23 to 2027/28) |
Difference |
|
|
£33,000 |
£27,378 |
£24,821 |
£2,557 |
10% |
|
£50,000 |
£53,265 |
£46,695 |
£6,570 |
14% |
|
£75,000 |
£117,602 |
£104,818 |
£12,783 |
12% |
Source: AJ Bell. Median full-time salary is £33,000, based on ONS figures from April 2022. Inflation rate from previous September applied in each tax year, for years 2024/25, 2025/26 and 2026/27 the Bank of England's latest projections for Q4 in the previous year is used, for the increase applied in 2027/28 the Bank of England inflation target of 2% is used. Wage growth figures taken from March 2022 OBR report, with 2027/28 figures based on average of previous years.
“The lifetime allowance controls how much can be built up in people’s pensions tax-free over the course of their lives. If you exceed the lifetime allowance, you could be hit with a charge of up to 55% on the excess.
“A lifetime allowance of just over £1 million might sound like a huge sum of money, but by freezing the level potentially beyond the end of this Parliament, the Government will drag significant swathes of middle Britain into its orbit. In particular, higher earning members of defined benefit (DB) schemes, including NHS workers, will be at increased risk of being on the hook for potentially crippling tax charges.
“For a defined contribution (DC) saver, a £1,073,100 pension pot – exactly equal to the lifetime allowance – could deliver an annual income (after taking their 25% tax-free cash) in drawdown of around £35,000 a year for 30 years*. The real value of this cap will be further eaten away the longer the lifetime allowance remains frozen.
“We estimate that if a CPI link had been retained for the entirety of this Parliament and remained in place until 2027/28, the lifetime allowance would be worth £1,332,000 – almost £260,000 more than the current level.
“So while this might seem like an attack on the wealthy, in reality it will impact on large numbers of ordinary working people.”
*Assumptions: £35,000 starting income rises by 2% each year, investment returns = 4% per annum after charges, fund runs out after approximately 30 years
How freezing the lifetime allowance until 2027/28 could hit pension savers:
|
Year |
Inflation rate |
Lifetime allowance (if inflation uprating had been applied) |
Actual lifetime allowance |
Difference |
|
2021/22 |
0.50% |
£1,078,500 |
£1,073,100 |
£5,400 |
|
2022/23 |
3.10% |
£1,111,900 |
£1,073,100 |
£38,800 |
|
2023/24 |
10.10% |
£1,224,200 |
£1,073,100 |
£151,100 |
|
2024/25 |
5.20% |
£1,287,900 |
£1,073,100 |
£214,800 |
|
2025/26 |
1.40% |
£1,305,900 |
£1,073,100 |
£232,800 |
|
2026/27 |
0% |
£1,305,900 |
£1,073,100 |
£232,800 |
|
2027/28 |
2% |
£1,332,000 |
£1,073,100 |
£258,900 |
Source: AJ Bell. Assumptions: inflation rate for previous September applied in each tax year and rounded to the nearest £100, for years 2024/25, 2025/26 and 2026/27 the Bank of England's latest projections for Q4 in the previous year is used, for the increase applied in 2027/28 the Bank of England inflation target of 2% is used
“Jeremy Hunt is also expected to freeze the inheritance tax bands for another two years – pushing more people into paying death tax. Despite just 1 in 25 deaths leading to inheritance tax being paid last year, it’s still widely regarded as the UK’s most hated tax.
“Extending the freeze from the current 2026 to 2028 will mean that the £325,000 tax-free allowance will be unchanged for almost two decades, during a period where house prices and other asset prices have risen dramatically. This is reflected in the government’s tax take, with £6.1bn paid in IHT in the past tax year – a more than £700m increase on the previous year.
“The freeze will make inheritance tax more mainstream and start hitting those who wouldn’t class themselves as wealthy, particularly if they aren’t eligible for the fiendishly complex residence nil rate band allowance.”
“Government tax changes are moving so fast taxpayers risk getting whiplash from the constant switches in direction. Dividend tax was set to be slashed from April next year, with the former chancellor promising in the mini-budget that the rates would be cut and the additional rate abolished altogether. Now they are looking down the barrel of a rate hike or their tax-free allowance being slashed.
“Any changes to dividend rates would affect the 2.6 million investors and company directors who pay tax on their dividends. But a move to cut the tax-free allowance would affect more people, who currently don’t pay any tax on their dividends because their annual pay-outs are within the limit.
“One option could be to simply raise rates from where we are. The previous 1.25 percentage point hike was expected to generate £1.4bn for the government, so another increase by 1% would raise a similar amount. The move would also bring dividend tax rates closer to income tax rates for higher and additional rate payers.
“Another option would be to cut, or scrap entirely, the £2,000 tax-free allowance for dividends. Scrapping it entirely would mean lots of people earning very little in dividends would have to file a tax return, meaning the administration would likely cost more than the tax take for those taxpayers. A more workable option would be cutting the allowance to £1,000 or £500.
“The move would not be popular. Investors and company directors getting dividend payments have faced a continual hike in tax over the past six years with rates being increased and the tax-free allowance having been slashed already.”
“Increasing so-called ‘wealth taxes’ could be a popular move with the wider public. A previous Office for Tax Simplification review put the idea of scrapping the current capital gains tax rates and replacing them with income tax rates on the table. However, a crucial part of that recommendation was that investors should also be given an inflationary relief, so they are only taxed on above-inflation gains. That final part may be ignored by the government to try to improve their tax take.
“Capital Gains Tax already generated £14.3bn last year for the government, with rising asset prices, house prices and frozen allowances all helping to push this up by 42% in the past year. A hike in rates from the current 10% to 20% for basic-rate payers, or 20% to 40% for higher rate payers would significantly boost government coffers.
“A less radical move would be for the government to cut the tax-free allowance from its current £12,300. The allowance has already been frozen until 2026, but Rishi Sunak could go one step further and cut the allowance. Chopping it in half, to £6,000, would generate £480m, while cutting it to £2,500 would give an £835m boost to government coffers, according to OTS predictions.”
- Scrap higher-rate pension tax relief – AJ Bell head of retirement policy, Tom Selby:
“The sword of Damocles appears to be constantly dangling over higher-rate pension tax relief, and it has become something of a tradition for rumours to emanate from the Treasury about its imminent demise ahead of Budgets and Autumn Statements. This is perhaps inevitable given the total net cost of pension tax and National Insurance (NI) relief was estimated at close to £50 billion in 2020/21.
“While successive chancellors have chipped away at pension tax allowances, higher-rate relief has remained untouched, despite estimates scrapping it could deliver an annual saving of around £10 billion.
“There are plenty of reasons why this might be the case. Most obviously, scrapping higher-rate pension tax relief would hit middle England directly in the pocket – a section of society the Conservative Party can ill afford to alienate.
“Automatic enrolment also remains relatively fragile – particularly given millions are facing a cost-of-living squeeze – and there may be concerns scrapping higher-rate relief could spur a rise in opt-outs.
“What’s more, the government would risk standing accused of intergenerational unfairness, given older generations will have had the chance to benefit from higher-rate relief, while younger workers would have the rug pulled from under them.
“But it is also entirely unclear how this would be applied to defined benefit (DB) schemes, and in particular the public sector. Whatever the method, the end result would be whacking great tax bills for large numbers of public sector workers.
“Pensions are already creating a significant squeeze on the NHS, and landing doctors with another tax bill to cancel out their higher-rate pension tax relief would risk a backlash of biblical proportions.”
Potential impact of scrapping higher-rate pension tax relief*
|
Annual personal pension contribution |
Upfront basic-rate tax relief |
Value of higher-rate relief (reclaimed from HMRC) |
Value of lost higher-rate relief over 35 years |
Potential value of lost higher-rate relief over 35 years (if invested**) |
|
£3,000 (£250 per month) |
£750 |
£750 |
£26,250 |
£57,449 |
|
£6,000 (£500 per month) |
£1,500 |
£1,500 |
£52,500 |
£114,897 |
|
£12,000 (£1,000 per month) |
£3,000 |
£3,000 |
£105,000 |
£229,795 |
*Assumes entire pension contribution qualifies for higher-rate tax relief
**Assumes higher-rate relief is invested each year and enjoys 4% investment growth after charges
“It is entirely possible the Treasury chose to raise the possibility of a dramatic and hugely controversial scrapping of higher-rate tax relief in order to soften the blow of pension tax tweaks elsewhere.
“One option could be to reduce the annual allowance, which currently stands at £40,000 and controls the total value of tax-incentivised contributions that can be made to a pension each tax year. If you breach the annual allowance, a charge will be applied which removes the upfront tax relief you received.
“Such a move would be less seismic than ditching higher-rate relief but would not be without problems or controversy. Once again, the big sticking point will likely relate to DB schemes – and specifically the NHS scheme.
“The British Medical Association (BMA) has previously warned the spike in inflation we have seen this year could lead to NHS practitioners being hit with pension tax charges running into tens of thousands of pounds1 – and that is assuming the annual allowance remains at £40,000.
“If the annual allowance is cut, there will clearly be a risk of more early retirements, placing further strain on the NHS.”
“Defined contribution (DC) pensions benefit from generous tax treatment on death under the current rules.
“If you die before age 75, you can pass on funds tax-free to your nominated beneficiary (or beneficiaries). If you die after age 75, your beneficiary (or beneficiaries) will be taxed on the money in the same way as income when they come to make a withdrawal.
“The Treasury could introduce a tax charge on death to raise extra revenue from retirees hoping to pass money onto loved ones tax efficiently. However, this too would come with significant challenges.
“Firstly, being able to pass on funds tax-efficiently on death will have been one of the primary motivations for contributing to a pension for some people. Slapping a new tax on that money would therefore leave many feeling like the chancellor has pulled the rug from under their inheritance plans.
“Secondly, it would risk being deeply unpopular, with predictable headlines of ‘pensions death tax’ likely to follow. Given the proximity of the general election, this might be enough to put Hunt and Sunak off going down this road.”
“The Autumn Statement will hopefully bring to an end the saga over whether or not the state pension triple-lock will be honoured next year.
“The triple-lock guarantees the state pension increases each year in line with the highest of average earnings, CPI inflation or 2.5%. September’s inflation figure is traditionally used for the triple-lock, implying a whopping 10.1% increase in the value of the state pension in April 2023.
“While former prime minister Liz Truss committed to the triple-lock during her final PMQs appearance, the current PM and chancellor have been unwilling to do so. This is perhaps understandable given an inflation-linked increase could cost in the region of £5 billion more than an earnings-linked rise.
“However, failing to honour the triple-lock for a second consecutive year would be a huge risk given where the Conservative Party finds itself in the polls.
“If the triple-lock is retained and the state pension is uprated by 10.1% next year, the full flat-rate state pension, paid to those reaching state pension age from 6 April 2016, will increase from £185.15 per week to £203.85 per week (£10,600.20 per year) from April next year.
“The basic state pension, paid to those who reached state pension age before 6 April 2016, will increase from £141.85 per week to £156.20 per week (£8,122.40 per year).
“However, if earnings growth for the three months to July (5.5%) is used instead, the full-flat rate state pension will rise to £195.35 per week – £8.50 per week (or £442 per year) less than a 10.1% inflation-linked increase.
“The basic state pension will rise to £149.65 per week – £6.55 per week (or £340.60 per year) less than a 10.1% inflation-linked increase.”
- Energy company windfall tax - Danni Hewson, financial analyst:
“For the man on the street, or at least the person paying the household energy bill, upping the level and duration of windfall tax seems like a no-brainer. With headlines screaming of record profits at energy giants while people struggle to find the cash just to turn on the kettle, many people have been left with a nasty taste in their mouth and even Shell’s outgoing boss has acknowledged windfall taxes are likely to be a ‘societal reality’. On the face of it, plugging the treasury coffers with money that’s blown off the windfall tree delivers an easy win but in reality, the chancellor has to pick his way carefully across a tightrope that’s slicked with some of the black stuff at the heart of the debate.
“BP has already handed over millions thanks to the energy profits levy but so far Shell has neatly avoided the tax by instead investing in North Sea oil and gas projects which triggered an offset in the form of investment relief, though it has written down hundreds of millions it expects to pay in the first quarter of next year. It was investment the government was worried about curtailing particularly when it needs big business to really focus on the shift to clean energy while keeping the lights blazing during that shift.
“Making more changes after the terms of the deal have been agreed won’t sit well with businesses. If they can’t trust the UK government to play by the rules it sets, they might look elsewhere to ply their trade – it’s not as if these aren’t multi-national companies with plenty of nations clamouring for their patronage. Extending it to electricity generators is also back on the table with discussions about a cap on the renewables sector to stop them cashing in on surging wholesale prices which are linked to gas prices.
“Quick wins might score points with voters and they might help fill that gaping hole in the public finances, but they can have other, unexpected consequences. The energy sector needs fundamental and sustainable changes and that will require good will and good amounts of cash.
“But the cost-of-living crisis is focussing minds and the government knows it needs to win over hearts as well.”