Understanding the potential for an income tax rise
The prospect of an income tax rise has dominated conversations as the Labour Party signals that today’s budget could include changes to how the levy is collected. While Labour has vowed not to increase the personal tax rate in its manifesto, the party has left room for policy shifts that could affect pay packets in other ways. Here, we break down how Reeves could increase income tax and what that might mean for different groups of people.
Where a future tax rise could come from
Even without a formal pledge to raise the headline income tax rate, there are several avenues that could effectively increase the tax burden. These include adjustments to tax bands and thresholds, changes to personal allowances, reform of dividend and savings taxation, and measures that influence National Insurance contributions in practice. Each mechanism changes the amount of income left in workers’ pay packets and the overall revenue raised by the government.
Raising revenue without increasing the top rate
One route is to tighten the bands that decide how much income is taxed at higher rates. By narrowing the bands or freezing them for a longer period, more of a person’s income could fall into higher tax brackets over time, even if the basic rate stays the same. This approach can raise taxes on a broader slice of earners, not just the highest incomes.
Altering the personal allowance
The personal allowance—the amount you can earn before paying income tax—has historically been a target for changes. Reducing or freezing the allowance, or introducing tapering for more earners, would raise tax bills for those in lower and middle income brackets, in addition to increasing revenue for public services.
Dividend and saving taxes
For those who own shares or rely on investments, tweaks to dividend tax rates or saving incentives can indirectly raise overall taxation. While these aren’t purely “income tax” changes, they affect the total tax burden and can influence how households manage investments and income.
What this could mean for different households
Any move to raise income tax or its effective burden would affect households unevenly. Here’s a snapshot of potential impacts:
- Lower and middle earners: If the personal allowance is reduced or bands are tightened, workers with mid-range incomes could see higher take-home pay reductions than today, even if the headline rate remains at 20% or 40% for some bands. The net effect depends on the balance of changes across bands and allowances.
- Higher earners: While the top rate itself may not rise, higher earners can still face greater taxation through narrowed bands and changes to eligibility for tax reliefs and investments.
- Savers and investors: Changes to dividend taxation or savings incentives could alter the return on investments, influencing household finances and long-term planning.
What to watch in the budget
As the budget approaches, look for announcements on: any freeze or reduction in personal allowances, adjustments to tax bands, and reforms that impact investment taxes. Government briefings and independent analyses will help households gauge their own situations and plan ahead.
How to prepare financially
While uncertainty remains, a few proactive steps can help you prepare:
- Review your take-home pay and anticipate changes in your tax code or band placement.
- Consider tax-efficient savings and investment strategies within current rules.
- Estimate potential changes to your pension contributions and benefits, which can be affected by broader tax policy.
Bottom line: Reeves’ signals indicate budget choices that could raise the effective tax burden in ways that reach beyond a single headline rate. Understanding these mechanisms helps you anticipate how your finances may shift and plan accordingly.
