One million extra prone to paying 40% tax: Chancellor might prolong freeze on thresholds

Another one million workers could be dragged into paying the higher rate of tax as speculation mounts that Rachel Reeves is preparing a raid on middle class earners.

The Chancellor is under pressure to raise taxes and cut spending to plug a £10 billion gap in the public finances or risk breaking her own borrowing rules.

Reeves has previously ruled out extending a freeze on income tax thresholds to the end of the decade. She is not expected to change her position in next week’s Spring Statement, but experts say sneaky tax rises are ‘likely’ later this year as growth stalls and Donald Trump’s actions prompt higher defence spending in the UK.

The stealth tax grab has its origins in a little-noticed move by Rishi Sunak in 2021.

As Chancellor he introduced a four-year freeze on tax thresholds. This pegged the level at which workers pay the 40p rate at £50,271 until 2026. That means people pay more tax even if their incomes have not gone up in real terms.

The phenomenon, known as fiscal drag, means the Government hauls in more revenue.

Sunak’s successor Jeremy Hunt said he would extend the freeze for another two years – a policy Labour has retained.

Initially the four-year freeze was expected to raise £8 billion a year. But the Office for Budget Responsibility (OBR), which monitors Government spending plans, now believes this policy will net more than £38 billion a year by the end of the decade due to higher-than-expected inflation. The latest figures show an extra 680,000 workers were pulled into the 40p tax bracket for the first time in 2023, bringing the total to five million.

Under current plans, this total is set to soar to nine million by 2028 as the freeze continues.

Prolonging it for two more years could take the number of higher rate taxpayers to ten million – double that of two years ago – according to independent economist Julian Jessop.

That could raise £10 billion a year as another 600,000 taxpayers are hit by higher and additional rates by 2030, according to the Institute of Fiscal Studies (IFS). A further 400,000 workers would also start paying income tax for the first time as wages rise, the think-tank added.

Extending fiscal drag ‘could certainly come in handy when dealing with rising defence, energy, day-to-day spending, and public sector pay pressure’, said Sanjay Raja at Deutsche Bank.

Stealth tax rises were ‘likely’ in the Autumn Budget, he added.

The impact of stealth tax rises has been laid bare by This Is Money, The Mail on Sunday’s sister website. Given that in 1997 the higher rate tax threshold was £30,200, if it had risen in line with retail prices, taxpayers would now start paying 40 per cent tax at £76,632, not £50,271.

The OBR will publish its outlook for the economy next week alongside Reeves’ update.

It is widely expected to slash its growth estimate of 2 per cent for the economy, which unexpectedly shrank in January.

Reeves appeared to blame the contraction on Trump, saying ‘the world has changed’.

The Chancellor has previously ruled out a further freeze on income tax and National Insurance thresholds, saying that it would break a manifesto pledge to ‘protect working people’.

Experts argue Reeves is boxed in by her own fiscal rules, which say day-to-day spending must be paid from taxes not borrowing by the end of the Parliament. Isabel Stockton at the IFS said: ‘Her commitments do not leave many options on the table.’

Reeves will try to balance the books next week by slashing red tape and public spending, including welfare cuts of up to £6 billion, reports say.

She plans to raise defence spending to 2.5 per cent of national income by 2027.

But experts say more may have to be spent on the military now Trump’s commitment to defend Europe is wavering.

A Treasury spokesman said: ‘At the Budget we announced we will not extend the freeze on personal tax thresholds and we are keeping our promise to not raise the basic, higher or additional rates of Income Tax, employee National Insurance or VAT.’