Key Takeaways
- An increase in UK income tax rates would be the first for around 50 years.
- Basic-rate taxpayers may be spared a tax increase, experts say.
- UK government also considering a wide range of other tax changes, from property to savings.
At the Autumn Budget on Nov. 26, the UK government is increasingly likely to breach its manifesto promise not to raise income tax, VAT or National Insurance.
While speculation has been increasing about likely changes to taxes across the board, most attention is focused on a potential increase to income tax. An increase of 2p on every pound, or a two percentage point tax increase, is believed to be under consideration.
This would be the first UK income tax increase in around 50 years, but is seen as near inevitable given the dire backdrop to the government’s crunch Autumn Budget. Inflation is elevated at 3.8%—nearly double the Bank of England’s target—and the UK economy grew by just 0.1% in August. In a fresh blow to the chancellor, the Office for Budget Responsibility is expected to cut its productivity growth predictions for the next five years. Borrowing costs have soared this year, but the government has had to perform U-turns on key policies that were originally designed to cut spending. Bond markets are jittery, and investors in UK government debt want to see lower public spending and public borrowing, or higher taxes to balance the books.
This means the chancellor may have to rely on significant tax rises to do the heavy lifting and bring the government’s “non-negotiable” fiscal rules back into line.
Rachel Vahey, head of public policy at AJ Bell, says the chancellor is now short of options.
“As rumors abound that the OBR is about to lower its productivity forecasts even further, Reeves’ hand may now be forced. She might have to do the previously unthinkable and raise income tax.”
How Does UK Income Tax Work?
UK income tax is divided into three bands in England, Wales and Northern Ireland:
- The basic rate is 20%, paid on earnings between £12,571 and £50,270. There is no tax to pay on earnings up to £12,570.
- The higher rate of 40% is paid on earnings between £50,271 and £125,140.
- The additional rate of 45% is charged on earnings above £125,140.
Changes to income tax rates are rare: an additional rate of 50% was brought in during 2010, however this was lowered to 45% three years later. But the threshold at which this rate kicks in was reduced from £150,000 to £125,000 in 2023.
Rather than direct increases to tax rates, “fiscal drag”, where frozen tax rate allowances pull more people into higher tax bands as wages rise, has been the preferred tool for previous governments. These thresholds are already frozen until 2028, with an extension expected until 2030. This has brought millions more people into higher or additional rate bands in the last few years.
Will Basic-Rate Taxpayers Escape the Fiscal Pain?
If Rachel Reeves wanted to avoid the suggestion that she has deliberately targeted voters on lower incomes, she could swerve increasing taxes on basic-rate ratepayers, experts say. But this less politically divisive option would raise less money and still constitute a breach of the original manifesto promise anyway as higher-earning workers shoulder the increase.
“The latest rumor, that the Treasury is considering raising the income tax rate … would probably only genuinely help the public finances if it is some form of basic rate increase,” says Daniel Lewin, tax partner at law firm Katten Muchin Rosenman.
Lewin adds that the other alternatives—including tax changes on the profits of partners of UK limited liability partnerships—will raise some revenue, but “further damage UK PLC as a destination for talent and economic growth.”
If Reeves puts 1p on income tax across all bands, Bina Gayadien, tax partner at law firm Spencer West, says the Treasury would be in line for an £8 billion revenue windfall. Whether a 2p increase would raise double that amount, is harder to assess: economic theory posits that increasing taxes does not lead to a proportionate rise in government revenue.
“Whether through direct tax rate increases or more structural reforms to the tax system, the chancellor will need to find billions from somewhere without breaching Labour’s manifesto pledges,” she says.
For basic-rate taxpayers, this would be an expensive hike at a time when households are already squeezed by inflation. AJ Bell estimates that an individual earning the average of £35,000 would pay an extra £200 in income tax every year with 1p increase in income tax.
What Other Tax Increases Are Planned By Chancellor Rachel Reeves?
Short of increasing income tax, plenty of other tax reforms are possible at the Budget. The government could remove National Insurance relief on salary sacrifice arrangements for workplace pensions, a move that would cost employers yet more on top of this year’s existing higher National Insurance employer contribution costs.
The government could also reduce the tax-free pension lump sum allowance, scrap pension tax relief for higher earners, overhaul capital gains tax on the sale of homes, reform council tax, change the cash ISA limits, scrap certain “gifting” exemptions under inheritance tax, make landlords pay National Insurance on their rental income, and even charge a levy on expensive homes—the so-called “mansion tax.” A supposed wealth tax has been mooted but at this stage seems unlikely.
But while experts agree taxation reform is an essential agenda, few see any easy ways for Reeves to raise the money she needs without either causing a political storm or damaging the UK’s already-vulnerable economy.
“Tax reform would be a laudable aim for Rachel Reeves to pursue, but it may also prove challenging while raising tax revenue at the same time, both politically and financially,” says Laith Khalaf, AJ Bell’s head of investment analysis.
“Property taxes in particular are highly emotive and likely to elicit a strong reaction among voters if they are seen to be rising. For that reason they would normally be a policy of last resort.”
Why Does the UK Government Need to Raise Taxes?
The Labour Party’s rhetoric on taxation has changed subtly but substantially over the past 18 months. In its 2024 general election manifesto, the party said it would “ensure taxes on working people are kept as low as possible.” It explicitly promised not to increase National Insurance, VAT, or income tax.
Today, that pledge has all but disappeared from the discourse, even as the phrase “keep taxes as low as possible” is still being used in official speeches.
For thinktank The Institute For Fiscal Studies, meeting the government’s “non-negotiable” fiscal rules of achieving either a balanced budget or a budget surplus by 2029/30, and public sector net liabilities falling as a share of GDP by that tax year, will require significant intervention.
“Using the Barclays central forecast for the economy, we estimate that the chancellor could see something like a £22 billion downgrade to the borrowing outlook for 2029—30, of which £6 billion results directly from reversing recent and planned cuts to social security spending,” the IFS said last month.
“This is the size of fiscal adjustment that would be required to restore the £10 billion of headroom against her borrowing rule that Rachel Reeves chose in the spring."
