The Office for Budget Responsibility has warned that workers will reduce their hours to avoid being pushed into higher income tax bands, as the Government extends the freeze on tax thresholds until 2031. The Budget watchdog forecasts that frozen thresholds could decrease labour supply by 215,000 hours annually. Income tax thresholds have remained unchanged since Rishi Sunak introduced a freeze in 2021, and the Treasury is now increasingly dependent on revenues generated by this freeze, which could bring in as much as £55billion a year by 2030.
The main driver of reduced working hours will be parents facing the £100,000 childcare cliff edge, according to the OBR. Families with one parent earning over £100,000 lose entitlement to 30 hours of free childcare and tax-free childcare worth up to £2,000 per year, in addition to losing child benefit. The OBR said it is possible that individuals earning above this threshold have reduced their hours worked to retain these benefits. If the childcare threshold had increased in line with inflation since its introduction, it would now stand at around £137,000.
The impact of frozen thresholds extends far beyond high earners. The tax-free personal allowance has remained at £12,570 for five years, even as wages have grown with inflation. If it had risen in line with inflation, it would be £16,080. A 21-year-old working 40 hours a week on the new minimum wage of £27,456 will pay £700 more in income tax this year and £6,100 more by 2030, assuming their salary keeps pace with inflation. Someone earning £50,000, at the cusp of the higher rate band, would pay £8,100 more by 2030 as fiscal drag pulls them into paying the 40p higher rate.
By 2031-32, the OBR forecasts that 6.7million more people will pay income tax and 5.4million more will be dragged into the higher rate band than if thresholds had risen in line with inflation. The overall tax burden is forecast to increase sharply from 36 per cent of GDP in 2025-26 to a record of 37.9 per cent in 2027-28, then continue climbing to reach a peak of 38.6 per cent of GDP in 2031-32. The Chancellor has partially addressed concerns for the poorest pensioners by raising their income tax threshold to £13,036 from next April, matching the full new state pension rate and preventing them paying tax on the state pension for the first time. However, there are concerns this may only apply to under-75s on the new state pension and could exclude older pensioners on the pre-2016 system, potentially creating a two-tier arrangement.
This means millions of working people across the UK will pay significantly more income tax over the coming years, while some may respond by working fewer hours, particularly parents with childcare costs and those earning above £100,000.