What could an income tax cut look like?

• 1p cut to the base rate of income tax: annual savings of £240 for a middle earner, £377 for a high earner, and £84 for a low earner.
• However, the annual savings would be higher if the personal allowance is increased in line with inflation - £408 for a middle earner
• If basic-rate tax threshold was increased to £14,000, to take account of two years’ worth of inflation, a middle earner would save £429.

Lower-than-expected government borrowing figures have raised hopes for a pre-election income tax cut in the Spring Budget.

An income tax cut could take various forms, such as lowering the basic rate of income tax and increasing the personal allowance (currently £12,570) and higher-rate thresholds. 

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However, calculations by interactive investor show that fiscal drag, where frozen tax thresholds increase taxable income without raising nominal tax rates, is likely to significantly reduce any reprieve in income tax.

What a 1p cut to the base rate of income tax could mean

interactive investor calculates that a person earning £35,000 would save £240 annually with a 1p cut to the base rate. However, the annual saving would be higher, £408, if the personal allowance also rose in line with the Office for Budget Responsibility’s inflation estimate of 4.6% for the 2024/25 tax year.

An individual with an income of £20,000 would save £84, and a person on £50,000 would get an extra £377 if there was a 1p cut to the base rate, compared to £251 and £809, respectively, if the personal allowance was uprated in line with inflation as well as a 1p cut.

If government unfreezes the income tax threshold

A person earning £35,000 would save £173 a year if the personal allowance rose in line with inflation – so too would someone on £20,000. The annual saving rises to £417 for an individual earning £50,000 if the personal allowance and higher rate income tax threshold increased in line with inflation.

If the government increases the basic rate income tax threshold to £14,000 to take into account two years’ worth of inflation

The uprating of the personal allowance to a round figure of £14,000, to take into account two years’ worth of inflation, would mean annual savings of £429 for those earning £20,000 and £35,000.

A higher earner with an annual salary of £50,000 would save £673 a year if the personal allowance was increased from £12,570 to £14,000 and the higher rate threshold was upped from £50,271 to £57,000.

Myron Jobson, Senior Personal Finance Analyst at interactive investor, says, “A juicy carrot in the form of a cut to income tax wouldn’t necessarily come as a big surprise in an election year. While any cut to income tax would be a welcome boost to households, especially after enduring a once-in-a-generation type cost-of-living crisis, fiscal drag is set to dilute any uplift – whichever form it might take.

“When thresholds and allowances are 'frozen,' there is an overall increase in tax paid to the Treasury without an actual increase in tax rates. Our calculations show that a middle earner could save £173 a year if the personal allowance was uprated by inflation. It is a sneaky tax grab, as people might not realise they are paying more in taxes simply due to inflation, making it seem less transparent compared to explicit tax increases.”

Alice Guy, Head of Pensions and Savings at interactive investor, says: “Fiscal drag has a devastating impact on people’s finances, especially during times of high inflation when wages are rising quickly. It means that more and more of your pay becomes taxable over time, leaving you with a higher personal tax burden.

“If you can afford it, then increasing your pension payments is one of the best ways to minimise the impact of fiscal drag. Because pension payments are tax free, you’ll get to save income tax on any contributions you make. For basic-rate taxpayers, it only costs £80 to pay £100 into your pension, and for higher-rate taxpayers, it’s an even better deal, costing just £60 to pay in £100 into your pension.

“Another way to save tax is to use salary sacrifice to make payments into your workplace pension. It means you’ll get to save national insurance as well as income tax, as your salary is officially reduced by the same amount as your pension contributions. For basic-rate taxpayers, it means saving a generous 10% national insurance on your pension contributions, giving your take-home pay a £10 boost for every £100 you pay into your pension.”

Source: interactive investor. Inflation figures - Office for Budget Responsibility forecasts.