Six sudden ways in which Labour may tax your earnings

Labour’s manifesto promises are already starting to unravel. 

Although the party won an election pledging not to increase National Insurance, income tax or VAT, it is looking increasingly likely that it will wriggle out of at least one of these promises.

Chancellor Rachel Reeves has said she has to find £22billion this year to plug a hole in public finances. 

But Labour has promised not to raise the three taxes that bring in the most money – and so may find ways to bend the rules it has created.

Sir Keir Starmer yesterday refused to rule out increasing National Insurance (NI) contributions paid by employers.

So, in what other ways could the Government backtrack on its manifesto pledges by relying on technicalities?

Money Mail investigates six possibilities – and what they could mean for your pocket.

Raising NI on employers

On the face of it, Labour’s manifesto tax pledge is as clear as day. ‘Labour will not increase taxes on working people, which is why we will not increase National Insurance, the basic, higher or additional rates of income tax or VAT,’ it says.

But ministers are now suggesting that only NI paid by ‘working people’ is covered by the pledge.

That would leave the Government free to increase it on employers. Companies currently pay NI at a rate of 13.8 per cent on all employees’ earnings above £175 per week. Increasing it by 1p could raise around £17billion a year, economists say.

But critics argue that the impact could be felt by working people – even if they are not stumping up the tax themselves.

Employers may think twice before hiring workers and increasing wages if the cost burden is higher.

Robert Salter, of tax firm Blick Rothenberg, says that, although the Government has promised not to hit individual workers, many would be directly impacted by an increase in NI on employers.

‘The reality is there are a lot of small business owners and they would take a hit as their costs go up. For example, a plumber who runs their own business would suddenly have to pay more NI on their own and their staff wages.’

Levy NI on pension contributions

While the Government could mount a full-scale assault on the NI paid by employers, tax and pensions industry leaders say that a targeted hit on pensions is just as likely.

One of the easiest and most tax-generative options at Ms Reeves’ fingertips is to charge a new NI levy on the contributions that employers pay into workers’ pensions.

Currently, employers do not pay any NI on money they pay into pensions on behalf of their staff. Think tanks, including the Institute for Fiscal Studies, have said this rule ‘should be reformed’. 

The IFS has estimated that if employers were charged NI on pension contributions at the same rate as they pay on wages (13.8 per cent), this would raise around £17billion per year.

Tom Selby, director of public policy at stockbroker AJ Bell, says: ‘This is the one of the most likely tax increases that Ms Reeves could announce given that the Government is in the business of finding the least worst options.

‘The Government has dug itself into a hole and put itself in a very difficult position by pledging not to hit working people. 

While it wouldn’t have a direct impact, levying NI on pension contributions would still have knock-on effects for working people.’

He warns that it could lead to employers cutting the amount they pay into their workers’ pensions, or affect future pay rises as businesses swallow the new cost. This could deal a significant blow to workers’ future retirement income.

Someone earning £35,000 today, whose salary increases by 2 per cent a year, would be £177,000 worse off after 35 years if their employer cut the amount they pay into their pensions from 8 per cent to the minimum of 3 per cent.

The calculations by AJ Bell found that someone earning £60,000 today would be £303,000 poorer in retirement. 

This rises significantly for companies with generous pension packages that decide to slash the amount they pay into their staff pensions.

Nearly half of employers that pay staff more than the minimum pension will consider reducing their contributions if the Chancellor introduces NI on employer pension payments, according to a poll of business decision makers by the Association of British Insurers and the Reward and Employee Benefits Association.

Combining NI and income tax

The Government could merge NI and income tax – and with a clever sleight of hand boost its coffers without technically raising either tax rate.

NI was originally set up separately to income tax to pay out state pensions and other welfare benefits. 

However, in reality income tax is sometimes used to top up the NI pot and the two no longer operate in isolation.

The Government could argue that merging the two is a simplification, which would slash red tape for both businesses and Government. 

Bringing the two taxes closer together has been called for over the years by the now-obsolete Office for Tax Simplification and the Institute for Fiscal Studies.

However, income tax applies to all sorts of income including savings, dividends and pensions, whereas NI applies to just earnings. 

If the two were merged – and NI was taxed on the same types of income as income tax – millions of households could end up paying more overall.

Mike Ambery, retirement savings director at Standard Life, part of Phoenix Group, says: ‘Merging would perhaps have the greatest impact on pensioners as pensions are investments, so in scope for income tax whereas in the current system those above state pension age generally don’t pay NI.

‘The new Government has committed to no rise in income tax or NI – however, merging the two would surely lead to an increase in the merged replacement to make up for the removal of one.’

He adds that it is ‘unlikely but not impossible that this change will be made in the near future’.

Scrapping salary sacrifice

Salary sacrifice is an attractive scheme that allows workers to boost their pension at no extra cost to themselves or their employer.

Workers agree to a reduction in their salary that is equal to the amount that they put into their pension. In return, their employer pays the employee’s total pension contributions into their pot.

The benefit is that, as the worker is sacrificing part of their salary, both they and the employee pay less in NI contributions – and the worker also pays less income tax. These savings can then be used to boost the worker’s pension.

A person earning an average salary and opting for salary sacrifice could boost their pension savings by £463 a year, according to analysis by Scottish Widows.

Getting rid of salary sacrifice would be a way for the Government to increase the amount it pulls in from both NI and income tax – but without technically increasing either rate.

However, millions of workers would take a hit to their retirement savings.

Say, for example, you earn £35,000 a year and contribute 5 per cent into your salary while your employer contributes 3 per cent. That would mean combined contributions of £2,800.

If you opted for salary sacrifice, your pension contributions would be subtracted from your salary, bringing it down to £33,250. 

Your pension contributions would stay at a combined 8 per cent, but would be paid directly into your pension, without any NI charged on it. 

If the NI saving is added to your pension, that would mean a combined contribution of £3,041.50 – amounting to an extra £241.50 into your pot every year at no extra cost.

Mike Ambery, of Standard Life, adds that some employers currently choose to hand over their tax savings to boost their employees’ pensions and these workers would be hit twice – from the extra tax they will pay themselves and the loss of extra cash from their employer. 

‘Lowest earners would be most affected as they currently benefit most from the additional money going into their pension pots,’ he adds.

Charging NI on other income

Although Labour has said it will not increase NI contribution rates, it could widen its net.

Pensioners could be roped into paying NI on their retirement income – despite having paid it their whole working lives.

Mr Selby, of AJ Bell, says: ‘Technically, it would not be a tax on working people. The fact that they pledged not to increase the rate on individuals probably means that this move would be deemed to be too toxic.’

Mr Salter, of Blick Rothenberg, says landlords could also be required to pay it on letting income. Money earned from letting out properties is not currently subject to an NI charge, unlike in many other countries such as France, he adds.

‘After all, why shouldn’t those who live off letting income pay NI?

‘But it may be the final nail in the coffin for struggling landlords.’

Extending freeze on income tax thresholds

The Government may have pledged not to increase income tax, but that does not preclude it from doing some clever fiddling to make millions of workers pay more.

Income tax thresholds have been frozen until April 2028, but Mr Salter warns the Labour Government could easily extend this freeze by a year or until 2030.

‘Extending the freeze for one year would be a massive revenue earner and would politically be quite easy to do,’ he says.

‘Officially, it doesn’t count as raising taxes so they wouldn’t have broken their manifesto promises. In 2029 they could then increase the thresholds and say it is a tax cut ahead of the next election.’

The current freeze on tax bands has already dragged an estimated 4.4 million into paying income tax in the UK in the past three years, according to official figures.

Mr Selby says a freeze on thresholds is the ‘sneakiest and most effective way for a government to raise tax revenues’.

Shaun Moore, tax and financial planning expert at wealth manager Quilter, says extending the freeze until 2030 would only worsen the pressure on households.

He says: ‘Income tax has already been a growing source of government income since thresholds were frozen until 2027/28, and an extension of this to 2029/30 would see the stealthy fiscal drag effect become increasingly lucrative.’

Someone earning £60,000 today, whose salary increases by 3 per cent a year, would pay an additional £3,579 in income tax between the 2028/29 and 2029/30 tax years compared with a situation where allowances had kept up with earnings, calculations by Quilter show.