Tax cut may be good for politics but not lower earners' back pockets

A cut to the basic rate of tax has been on and off the table several times over the last year or so. Rishi Sunak originally promised to cut the basic rate of income tax by 1% to 19% from 6 April 2024 during his time as chancellor. He then went even further in his Conservative party leadership campaign and pledged to reduce the basic rate of income tax even more to 16% by the end of the decade. As part of the mini-Budget spending spree by the Truss administration, the 1% tax cut was to be accelerated and introduced from 6 April 2023. Then the tax cut was reversed entirely by Jeremy Hunt and delayed indefinitely.

Confused? Many taxpayers will be. This has been an elaborate hokey cokey of tax policy, but rumours abound that we might finally see this elusive tax cut introduced from 6 April 2024. Alongside the rumoured tax cut is a reported increase to the national minimum wage, from £10.42 per hour for the current 2023/24 tax year to £11.16 per hour from April 2024.

Questions remain, however, as to whether this proposed tax cut is the right policy. A reported justification for introducing it is that it is simple for taxpayers to grasp. With a general election starting to loom on the horizon, this tax measure could be good for party politics but bad for some taxpayers’ back pockets.

Latest statistics shows that £67.9bn in income tax was paid by 27.2m basic rate income taxpayers during the 2022/23 tax year. A cut in the basic rate of income tax to 19% could potentially reduce this tax bill by around £3.4bn to approximately £64.5bn. This would equate to an average tax saving for each basic rate taxpayer of around £125 (before taking into account the potential number of new basic rate taxpayers due to the freezing of the personal allowance). However, average figures of tax savings do not tell the whole story.

The cost to the government of cutting the basic rate of income tax is currently estimated by HMRC to be around £6.8bn each year from the 2024/25 tax year onwards. In contrast, the total savings for the Exchequer from the freezing of the personal allowance and higher rate tax band is estimated to be around £25.5bn a year by the 2027/28 tax year, according to the latest Office of Budget Responsibility figures.

These additional tax revenues for the Treasury will come from lower earners being dragged into the tax net, as well as those being dragged into the higher rate of income tax. It’s not clear that a 1% cut to the basic rate of income tax is the best use of these funds to deliver savings to these groups of people.

It makes for a flashy political announcement but with its simplicity comes a lack of sophistication. The tax cut will benefit everyone, including higher earners, who could benefit from a saving of £377 if introduced next year. In contrast, individuals on a £15,000 salary would only benefit from a £24 saving and those on a £20,000 salary would benefit from a £74 saving. The measure is regressive in the sense that the tax savings increase for those with higher incomes.

An arguably more targeted approach would be to increase the personal allowance instead. This has been a tried and tested method of delivering tax savings to lower earners, but it seems confidence has been lost that it will deliver the political bang for buck deemed necessary.

We estimate an increase in the personal allowance of £880 is likely to cost around the same to the Treasury as the proposed 1% tax cut. That would produce a much more even saving to taxpayers, around £175 per person for most, but that saving would be restricted or lost entirely by those with incomes over £100,000 due to how the personal allowance operates. Ultimately, the desire for a wide-ranging tax cut that the majority can benefit from may win out. However, lower earners should be aware that such a measure could be more about prioritising political style over substantial tax savings.