British workers and the companies that employ them will be hit by the biggest payroll tax rise of any developed country, according to new analysis from the Organization for Economic Co-operation and Development (OECD).
The Paris-based body’s annual payroll tax audit puts the blame squarely at the door of Chancellor Rachel Reeves, whose October 2024 budget raised employers’ national insurance contributions and extended the freeze on income tax thresholds – a combination that has quietly tightened the screws on payrolls across the country.
For an average-earning worker in the UK, the so-called “tax wedge”, the gap between what it costs an employer to register an individual on the accounts and what the employee actually takes home, rose to 32.4 per cent last year, up from just under 30 per cent the year before. This increase of 2.45 percentage points dwarfs the OECD-wide average increase of just 0.15 points and surpasses all other countries in the 38-nation study. Only Estonia (1.95), Germany (1.34) and Israel (1.09) recorded increases of over one percentage point.
While the UK’s absolute tax burden is still below the OECD average of 35.1 percent, it is the speed of change that worries economists. The OECD warned that a widening wedge “tends to reduce the incentive to work and hire by reducing take-home pay and increasing employers’ labor costs”, a particularly painful message for the small and medium-sized businesses that dominate the UK private sector payroll.
The damage can be traced back to two conscious decisions in the Chancellor’s first budget. Firstly, Reeves reduced the earnings threshold at which employers must pay national insurance contributions from £9,100 to £5,000. This move hit hardest those companies that employ part-time and low-paid workers, such as cafes, nursing homes, mom-and-pop shops and hotel operators. Second, the overall employer social insurance rate increased from 13.8 percent to 15 percent.
The Treasury’s £25 billion-a-year revenue boost has come with a more hidden levy: income tax thresholds remain frozen at 2021-22 levels until 2031, pushing more workers into basic and higher tax rates as nominal wages rise, a phenomenon known as “fiscal drag”.
The labor market is already showing tension. Since the Chancellor first presented the employer NI increase in October 2024, the number of dependent employees has fallen by 143,000, according to official figures. The inactivity rate, the proportion of working-age adults who are neither working nor looking for work, rose to 21 percent in the three months to February, compared with 20.7 percent in the previous quarter.
The deterioration follows the eight-week-old US and Israeli airstrikes on Iran, which the OECD warned this month would give Britain the biggest drop in growth in the G20 and the biggest jump in inflation in the G7. Economists expect unemployment to continue rising as households and businesses cut spending to cope with rising energy costs caused by the conflict.
The OECD has repeatedly called on successive governments to address the “high compliance costs” embedded in Britain’s tax code, arguing that complexity itself is a constraint on hiring and growth. For the country’s SMEs, already struggling with higher borrowing costs, sluggish consumer demand and an uncertain global environment, the twin pressures of a rising tax burden and an increasingly Byzantine regulatory framework are making the case for reform harder to ignore.
Whether the Chancellor heeds this advice in her next budget will be closely watched by business owners, who have suffered a rise in employment costs over the last eighteen months that is unparalleled anywhere in the developed world.
