Frozen personal tax allowance and its consequences
In the UK, the government has recently announced that they will be freezing various tax allowances for the next five years. This move is likely to have a significant impact on many individuals and households, particularly those
whose income is increasing at a rate of 5% per annum. In this blog post, we will explore what this freeze means, and how it could affect people's finances.
Firstly, let's take a closer look at what is meant by frozen tax allowances. Tax allowances are the amounts of income that are not subject to tax. For example, the personal allowance is the amount of income that you can earn before you start paying income tax. By freezing these allowances, the government is essentially keeping them at the same level for the next five years, rather than increasing them in line with inflation as they have done in previous years.
Now, let's consider how this freeze could impact individuals whose income is increasing at a rate of 5% per annum. If your income is increasing at this rate, it means that you are earning 5% more each year than you were the previous year. However, because the tax allowances are frozen, you will be paying more tax each year on your increased income.
To illustrate this point, let's consider an example. Let's say that you currently earn £30,000 per year, and your income increases by 5% per annum. After five years, your income would have increased to £38,142. If the tax allowances had increased in line with inflation, you would still have a personal allowance of £12,570, meaning that you would pay tax on the remaining £25,572 of your income. However, because the tax allowances are frozen, your personal allowance would still be £12,570, meaning that you would pay tax on £25,572 in the first year, but on £25,572 plus the additional income in the subsequent years.
This means that, over the five-year period, you would pay significantly more tax than you would have done if the tax allowances had increased in line with inflation. In fact, according to the Institute for Fiscal Studies, the freeze on tax allowances is expected to raise an additional £8 billion per year for the government by 2025-26.
So, what does this mean for individuals and households? Well, for those whose income is increasing at a rate of 5% per annum, it means that they will have less disposable income than they would have done if the tax allowances had increased in line with inflation.
In conclusion, the freeze on tax allowances in the UK is likely to have a significant impact on individuals and households. It will mean that people will pay more tax on their increased income, reducing their disposable income and potentially making it more difficult to make ends meet. It remains to be seen how this will play out in practice, but it is clear that the freeze on tax allowances is a significant change that will affect many people's finances.