Wage growth and frozen allowances causes 44% leap in higher-rate taxpayers

Laura Suter, head of personal finance at AJ Bell, comments on the latest Government figures on income tax payers:

“A destructive combination of rising wages and frozen tax bands means that there will be a near 50% increase in the number of additional rate taxpayers, and a 44% in the number of higher-rate taxpayers this tax year.

“Data from the Government shows that the number of people paying the 40% rate of income tax will rise to 5.5m in the 2022/23 tax year – a 44% leap compared with pre-Covid times of 2019/20. The number of the very highest earners, paying 45% income tax, will rise to 629,000 – 49.4% higher than in 2019/20.

“While salaries are failing to keep pace with rocketing inflation, we are still seeing significant wage growth as the war for talent and rising living costs have led companies to push up pay packets. This coupled with frozen tax allowances means that more people are being pushed into higher tax brackets. 

“The income tax bands were frozen from the current tax year, with the personal allowance remaining at £12,570, the point where 40% income tax kicks in staying at £50,270 and where the top rate of 45% hits at £150,000. If the personal allowance and higher rate thresholds weren’t frozen, we’d be expecting them to rise with inflation, though in reality the Chancellor might well have baulked at increasing thresholds by 7% or 8%, even if he hadn’t chosen to freeze allowances.

“The latest ONS figures show wage growth year-on-year was 6.8%. Someone earning £47,500 last year who would have been a basic-rate taxpayer but saw average wage growth would now have tipped into the higher-rate tax bracket. Meanwhile someone who earned £140,500 last year and would have been in a higher-rate tax bracket would now have seen their wages rise to above £150,000 and the additional rate tax bracket.

The five-year picture

“The picture looks worse over the five-year period of the frozen tax bands. As a result millions of people are going to get dragged into the higher tax bands. Based on OBR forecasts, we calculate that the personal allowance would reach £15,300 in 2026/27 if uprated in line with CPI, but will only sit at £12,800 if frozen until 2025/26. Likewise, if uprated in line with the OBR inflation forecasts, the higher rate threshold would reach £61,200 in 2026/27, but as it is, with thresholds frozen for four years, we can expect it to sit at just £51,200.

“Those who are just below the thresholds currently are likely to feel the sharpest burn, because if thresholds were rising with inflation, this would help them keep out of a higher tax bracket. Based on OBR forecasts for average earnings, we estimate that anyone who is currently earning above £43,600 is now in danger of being dragged into the higher rate tax bracket by wage increases in the next five years.”
 

Sources: AJ Bell, ONS, OBR