Tax threshold freezes to create 2.5m new higher rate taxpayers - LCP

There will be a surge in the number of people paying income tax at the 40% rate or above during this this Parliament as a result of a long-term freeze in tax thresholds and rampant inflation, according to analysis by pensions consultancy LCP.

In 2021, the HMRC estimated there were 4.3m people paying income tax at the higher rate of 40% or the additional rate of 45% at the time of the last election in 2019/20. It also estimated the number of higher rate taxpayers would have grown to 4.6m people by 2021/22, an increase around 300,000.

However, LCP highlighted these HMRC estimates were based on Office for Budget Responsibility (OBR) estimates for wage growth from March 2021, which have since changed significantly.

HMRC's estimate of the number of higher rate taxpayers in 2021/22 was based on assuming a growth in total wages and salaries of 0.9% in 2020/21 followed by an increase of 2% the following year, giving a combined increase of 2.9%. However, OBR's new estimate of wage and salary growth by 2.6% in 2020/21 and 7.5% in 2021/22 provides a combined increase of over 10%.

This greater-than-expected increase in taxable incomes between 2019/20 and 2021/22 means the number of higher rate taxpayers in 2021/22 is likely to be closer to 5.2m, according to LCP, which is an increase of just under one million higher rate taxpayers since the general election in 2019.

In addition, three more years of relatively rapid wage growth, coupled with a freeze on tax thresholds, could bring a further 1.5m people into higher rate tax by the time of the next election, making a total of 2.5 million more over the whole Parliament, said LCP's partner Steve Webb. As a result, more than one in five taxpayers will be paying at the higher rate in 2024/25 compared with fewer than 1 in 10 in 2010/11, according to this analysis.

Webb, a former pensions minister, added: "There is no doubt that freezing tax allowances and thresholds is the ultimate stealth tax. No minister has to announce a rise in tax rates, but tens of millions of people pay more tax, and millions of those will even be dragged into higher tax bands purely because of wage inflation. 

"This is certainly not a transparent way of raising extra tax revenue. However, it does mean that millions of people now have a much bigger incentive to put more money into their pensions, potentially enjoying double the rate of tax relief on any contributions."