Higher earners face £377 bill if Reeves puts up income tax – do you fit the Treasury’s definition of ‘working people’?

A tax rise that would hit employees, pensioners, landlords and savers could be coming in the Budget after prime minister Keir Starmer seemed hesitant to rule out an income tax hike.

Putting just a penny on the basic rate of income tax in the Autumn Budget would cost more than £1 a day for higher earners, according to analysis by investment platform AJ Bell – equating to up to £377 a year in extra tax, with anyone earning £50,270 or more facing the maximum hit.

It could also raise almost £7 billion next year for the Treasury, according to HMRC estimates.

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Laura Suter, director of personal finance at AJ Bell, said: “If the government wanted to change income tax, the most straightforward option would be to add 1p to the basic rate of tax, increasing it from 20% to 21%.”

Asked at Prime Minister’s Questions yesterday if the government would stick to its election manifesto pledge not to raise National Insurance, VAT or income tax, Starmer refused to rule the idea out. He said the government’s plans would be laid out at the Autumn Budget on 26 November.

Starmer’s reluctance to repeat the pledge – which in the summer he had confirmed would remain in place – has given rise to speculation an income tax rise could be on its way.

Will income tax rise in the Budget?

The government is faced with the issue of having a fiscal hole to fill and needing to raise money to do so. With an estimated shortfall ranging from £50 billion (according to independent think tank the National Institute of Economic and Social Research) and £27 billion according to analysts at KPMG, it’s not going to be an easy gap to plug.

“While tinkering with other taxes may raise small amounts here and there, an increase to income tax raises a big chunk of money in one move – approximately £7 billion by the government’s own estimates,” said Suter.

While Starmer’s seeming reluctance to stand by his party’s pledge not to raise tax on ‘working people’ has given rise to the latest rumours about hikes, reports elsewhere have suggested the government is seeking to use a new definition of working people to get around the pledge.

According to Sky News, the broadcaster has obtained an internal description of ‘working people’ used by the Treasury, in which officials have reportedly been tasked with protecting the income of the lower two-thirds of working people.

While this means people earning more than around £46,000 could potentially be targeted for tax rises in the Budget, this is likely to rule out increases to the basic rate of income tax and National Insurance, since people earning less than that would pay more tax.

The Treasury declined to comment on the speculation. But a Treasury spokesperson told MoneyWeek: “The chancellor has been clear that in the Budget she will strike the right balance between making sure we have enough money to fund our public services and ensuring we can bring growth and investment to businesses.”

How much would a 1p rise in income tax cost?

Adding 1p to the basic rate of income tax would cost someone on an average income of £35,000 another £224 a year. Taxpayers with an income of £50,270 would incur the maximum £377 increase.

Source: AJ Bell. Annual income tax bill based on income taxpayers with the standard personal allowance. Rounded to the nearest £1. Those with earnings over £100,000 would be hit by the additional cost of the loss of personal allowance.

While hiking the basic rate of income tax would hit every income taxpayer in the UK, a more nuclear option would be to add one percentage point onto all income tax rates, also taking the higher rate up to 41% and the additional rate to 46%.

“While it’s possible income tax rates could be hiked across the board, higher and additional rate taxpayers already account for a disproportionate share of the income tax take,” pointed out Suter. “An increase to the basic rate is easier to position as a shared burden since it affects almost all workers, as well as pensioners and some savers.”

Increasing the basic rate to 21% would raise £6.9 billion in the next tax year and £23.4 billion over the next three years, based on HMRC figures. In comparison, hiking the higher rate to 41% would raise £1.6 billion next year and increasing the additional rate to 46% would raise a relatively paltry £145 million in extra tax revenue.

Is there an alternative to raising income tax?

One option put forward by the Resolution Foundation, a think tank, is raising income tax but offsetting the impact on employees with an equivalent cut to National Insurance.

“That would raise overall tax rates for pensioners, landlords, savers and perhaps those with dividend income too, while offsetting the impact on workers,” said Suter.

Given the manifesto pledge focused on workers – a definition the government is struggling itself trying to pin-down – the chancellor may be able to argue this policy raises taxes without breaking the spirit of the pre-election promise.