New analysis from LCP partner Steve Webb suggests that a combination of faster than expected wage growth and the freezing of tax thresholds will result in millions more people being dragged into paying higher rate income tax during the course of this Parliament.

The key facts are:

• According to HMRC figures published in June 2021, at the time of the last election in 2019/20 there were 4.3m people paying income tax at the higher rate of 40% or the additional rate of 45%.
• When HMRC published this analysis last year, they also estimated that the number of higher rate taxpayers would have grown to 4.6m people by 2021/22, an increase around 300,000;
• However, when HMRC published their estimates in 2021, they only had access to OBR estimates for wage growth published in the March 2021 Economic and Fiscal Outlook. Since then, the OBR has dramatically increased its estimate of wage growth to date, and into the future. The table shows the changes in the OBR’s assumptions between the two reports:

Table: Percentage growth in wages and salaries compared with previous year

Source: Economic and Fiscal Outlook, OBR, March 2021 and March 2022

Using the figures from the table above, HMRC’s estimate of the number of higher rate taxpayers in 2021/22 was based on assuming a growth in total wages and salaries of 0.9% in 2020/21 followed by an increase of 2.0% the following year, giving a combined increase of 2.9%.  However, OBR now thinks that wages and salaries grew by 2.6% in 2020/21 and 7.5% in 2021/22 giving  a combined increase of over 10%, more than three times as fast. 

Using published HMRC data on the distribution of taxable incomes and tax deductions, Steve Webb estimates that this much greater than expected increase in taxable incomes between 2019/20 and 2021/22 means the number of higher rate taxpayers in 2021/22 is likely to be closer to 5.2m, an increase of just under 1 million higher rate taxpayers since the Election.

As the table shows, OBR is now also assuming a further cumulative increase in total wages and salaries of over 12% in the three years to 2024/25 (assumed Election year).  This is over a period when the threshold for higher rate income tax will remain frozen at £50,270.

It is estimated that this rapid pay inflation is likely to bring an extra 1.5m people into higher rate tax compared with 2021/22.

In total, it seems likely that up to 2.5m extra people could be brought into higher rate tax between the general election in 2019 and an election in 2024/25.  This means more than 1 in 5 taxpayers will be paying at the higher rate in 2024/25 compared with fewer than 1 in 10 in 2010/11.

Commenting, Steve Webb said:

“HMRC admitted last year that it thought over a third of a million extra people would be brought into higher rate tax in the first two years of this Parliament.  But that was before the surge in wage levels as the economy has bounced back from the Pandemic.  As a result it is likely to be closer to a million people who have been brought into higher rate tax so far.  In addition, three more years of relatively rapid wage growth coupled with a freeze on tax thresholds could bring a further 1.5 million people into higher rate tax by the time of the next election, making a total of 2.5 million more over the whole Parliament.

“There is no doubt that freezing tax allowances and thresholds is the ultimate stealth tax.  No minister has to announce a rise in tax rates, but tens of millions of people pay more tax, and millions of those will even be dragged into higher tax bands purely because of wage inflation.  This is certainly not a transparent way of raising extra tax revenue”.

1. HMRC’s most recent estimates of the number of higher rate taxpayers up to 2021/22 were published in June 2021, and can be found at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1020275/Table_2.1.ods
2. The number of people paying tax at different rates will depend on the growth in all sources of taxable income, including self-employment profits, investment incomes and pensions, as well as wages and salaries. However, wages and salaries are likely to be the most important component of taxable income, especially for those close to the higher rate income tax threshold.  The wages and salaries figure has therefore been used as a proxy for the movement in total taxable income.