Low Incomes Tax Reform Group: Freezing personal allowance gives opportunity to align tax and national insurance thresholds

Taxpayers may be disappointed by today’s Budget announcement that the personal income tax allowance will be frozen at £12,570 from the 2021/22 tax year, through to 2025/26.1 Depending on wage inflation over those five tax years, this could result in people paying more income tax in real terms.2 However, for those claiming universal credit, the Low Incomes Tax Reform Group points out that this blow is softened because that benefit is calculated on net income.3

For example, an inflationary increase of around 1% would have increased the personal allowance from £12,570 in 2021/22 to £12,700 in 2022/23. This extra personal allowance of £130 would have saved a basic rate taxpayer £26 of income tax at 20%.

However, a universal credit claimant who pays income tax would only have gained the benefit of 37% of that saving, after applying the taper of 63% – just under £10. 

So, while the freeze means that people will ultimately pay more tax, those at the lower end of the income scale are cushioned from its full effect. 

Victoria Todd, Head of LITRG, said:

“Although freezing the personal allowance for a period of five years will mean that anyone earning above £12,570 will end up paying more tax, we think there is an opportunity for the government to use this period to benefit those on the lowest incomes and reduce complexity.

“Those earning between the class 1 primary National Insurance threshold – or, if self-employed, the class 4 lower profits limit4  and the personal allowance do not benefit from increases in the personal allowance. The cost on them is National Insurance (at 12% for the employed and 9% for the self-employed respectively). 

“Freezing the personal allowance for five years gives an opportunity – in line with the government’s 2019 manifesto commitment5 – to continue aligning the point at which classes 1 and 4 National Insurance begin to be paid with the personal allowance. 

As well as benefiting those on the lowest incomes, because national insurance will not be paid until income reaches a higher pointhaving two different thresholds for tax and NI also causes confusionWe hope that the government will use future fiscal events to deliver on this commitment.6