Why lowering tax thresholds will cost workers more than an income tax rise ...Middle East

Lowering the income tax thresholds would cost most workers more than a previously mooted “two-up two-down” plan to raise income tax rates while cutting national insurance, according to economists.

Rachel Reeves considered a Budget proposal known as “two up, two down” which would have seen the Treasury increase the rate of income tax by 2p and reduce employees’ national insurance contributions by the same amount.

She has now definitively decided against raising income tax, which would have been a breach of a promise in Labour’s general election manifesto. The change of heart came after a pick-up in the public finances meaning that the Chancellor needs to raise less revenue than previously thought.

The Financial Times reported that one option still on the table, which would not break the wording of the manifesto, was to lower the thresholds at which people start to pay the basic, higher and additional rates of income tax.

This proposal – which Bloomberg and the Guardian said is no being ruled out by the Treasury – would raise less revenue than an increase in rates.

But for most workers, who make their money through a salary rather than other forms of income such as rent or pensions, it would cost them more than the “two up, two down” idea – with the exact size of the tax hit depending on where the thresholds ended up being set.

That is because the amount of their earnings shielded from tax would be reduced, even though the tax rate would not increase.

Tom Waters of the Institute for Fiscal Studies told The i Paper: “For a typical worker who is paid the same amount throughout the year and has no other unearned income, ‘two up, two down’ doesn’t affect their overall tax liability.

“It would raise tax for those who get unearned income – landlords, pensioners etc. By comparison, reducing income tax thresholds raises tax for anyone with income above the income tax personal allowance (£12,570).”

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The “two up, two down” proposal was put forward by the Resolution Foundation as a way of raising £6bn for the Treasury while shielding the majority of workers from having to pay more.

Income tax is applied to a wider range of income sources than national insurance, which is levied only on employment income and is not paid by pensioners. That means that moving 2p from national insurance to income tax has no effect on those who make all their money from work as the two moves cancel each other out.

The thresholds for each of the three rates of income tax are supposed to rise each year in line with inflation. But they have been frozen since 2021 and are not scheduled to go up again until 2028 – with the Chancellor highly likely to extend that freeze for another two years at the Budget.

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