Investment platforms AJ Bell and IG have joined a growing number of tax and financial experts in calling for UK chancellor Rachel Reeves to remove “cliff edges” from the tax system, arguing that they disincentivise work and damage growth.
The appeals come after The Office for Budget Responsibility forecast the UK’s tax-to-GDP to increase to a post-war high of 38.5 per cent of GDP in 2030-31 and that marginal tax rates may damage incentives to work, save and invest.
“A higher level of the tax take increases the risk that incentives within the tax system distort or constrain economic activity by more than expected,” it warned on Tuesday, following the chancellor’s Spring Statement.
The starkest of the UK’s tax cliff edges is the threshold between £100,000 and £125,140 where earners face an effective marginal tax rate of more than 60 per cent and free childcare hours for nursery age children is withdrawn. The issue is worse for high-earning graduates who may also have student loan repayments deducted from their earnings.
A survey for IG published this week found that around half of so-called Henrys (“High earners, but not rich yet”) who earn between £90,000 and £125,000 said they cannot invest enough to build future wealth due to tax and financial pressures. That figure rose to 92 per cent for parents with nursery age children.
“When earning more leaves you with less capacity to invest, that’s not just a household issue — it’s a structural problem,” said Michael Healy, UK and Ireland managing director at IG.
“The UK’s brutal tax cliff edge system is weighing down the very households who are most able to fuel growth in UK capital markets.”
Laura Suter, AJ Bell’s director of personal finance, warns Reeves could come under pressure to address what she describes as “glaring issues with the UK’s tax system”.
“With higher earners in particular suffering from punitive rates of tax that means working towards a pay rise is hardly worth the effort in many cases,” she said. “That’s clearly not a sensible way to encourage growth or incentivise workers to progress or take on new roles.”
The issue has been made worse since April 2022 because successive governments have frozen several allowances and tax thresholds, including income tax thresholds, rather than raising them in line with inflation.
The move has increased tax receipts as higher pay tips more workers either into the tax system or on to higher rates, a phenomenon known as “fiscal drag”.
“[The chancellor] talking about boosting GDP by 5.6 per cent by the end of this parliamentary term means little if those modest gains are swallowed up by rising tax burdens,” warned Gail Boag, chief executive at the Institute of Chartered Accountants of Scotland.
If thresholds had risen in line with inflation, the personal allowance would now be around £15,550 instead of £12,570, Icas calculated, while the higher-rate threshold would be around £62,000 rather than £50,270.
Boag called on the government to use the time between now and the autumn Budget to come up with a long-term tax strategy “that genuinely supports work, attracts investment and drives economic growth”.
“Fiscal drag asks people to do more with less. Forcing households to stretch their shrinking budgets even further doesn’t incentivise work at a time of high unemployment, fails to boost productivity or spending, and erodes trust in the tax system,” she added.
However, others added that while unpopular, they did not expect the chancellor to fix the issue any time soon. Olly Cheng, financial planning divisional lead at wealth manager Rathbones, argued that the frozen thresholds were doing a lot of “heavy lifting for the public finances”.
“The OBR’s latest outlook makes it less likely the chancellor will want to address the £100,000 tax trap at this Budget,” he said.
A recent freedom of information request submitted by the firm revealed that more than 2.3mn people are set to be earning more than £100,000 by April 2029, meaning many more will be caught by the withdrawal of the personal allowance.
The issue could be worsened if the situation in the Middle East triggers higher inflation and leads to more people being dragged into higher bands, due to wage growth.
“From the Treasury’s perspective, that makes fiscal drag an unattractive policy politically, but a very effective one fiscally,” Cheng added.
The OBR has pledged to investigate the issue further in a report due to be published later this year.
The Treasury said: “The tax system remains highly progressive, with those with the broadest shoulders contributing more to support measures such as freezing fuel duty to the end of August, freezing rail fares and prescription charges.
“The personal allowance taper impacts fewer than 4 per cent of parents, and we’re encouraging retail investing through reforming cash Isas and by giving people clearer information and bespoke support from banks.”