A failure to cancel the freezes in tax-free thresholds is expected to reap the Government a £30bn tax windfall as more workers will pay more tax or larger amounts.
The move by Chancellor Kwasi Kwarteng to keep the tax-free earnings threshold of £12,570 frozen for the next four years will be extremely lucrative for the Government.
Analysis by the Institute of Fiscal Studies calculated that, as of last year, keeping the threshold the same – and not increasing it in line with inflation – would make the Treasury £8bn over four years. However, with inflation rising far faster than predicted, dragging more people to pay tax for the first time as wages and pensions increase, the IFS now suggests the figure could be £30bn.
This so-called ‘fiscal drag’, where greater numbers of workers are dragged into paying tax, is unpopular as it is effectively when tax by stealth – a move that many Chancellors, especially Rishi Sunak, were fond of.
When child benefit was reformed in 2013, if someone in a household earned more than £50,000, the family would start losing some of their child benefit. Once their earnings hit £60,000 they lost the entitlement altogether.
However, if the £50,000 threshold was not frozen, and instead rose in line with inflation, it would be at least £58,000 now, according to the Institute of Fiscal Studies.
The freeze therefore means that some basic-rate taxpayers who earn little more than £50,000 are now losing child benefit.
This phenomenon is also likely to have a large effect on pensioners. Nearly half a million more pensioners are likely to start paying tax next year once the triple lock pension guarantee is restored. This will mean their pension income will see them receiving more than £12,570 for the firs time, as inflation pushes up their pensions.
The state pension is expected to rise in line with the CPI measure of inflation based on the 9.9 per cent rate in August.
Tom Waters, senior research economist at the Institute for Fiscal Studies, said: “The Chancellor could have cancelled the freeze, which would have been a big tax cut relative to current plans, but he chose to keep it.”
Sunak’s fondness for leaving tax thresholds where they were was a feature when inflation was relatively low, meaning that wage rises were relatively muted.
But with price rises now hitting four-decade highs, wages in some parts of the economy are beginning to rise more markedly compared with a year ago.
David Hearne, a chartered financial planner at Financial Planning Partners, said: “Fiscal drag is making more and more people become higher-rate taxpayers, perhaps providing the funding needed to cut the basic rate of tax to 19 per cent.”
Stephen Herring, a former head of taxation at the Institute of Directors, said he “really hates fiscal drag”. He said: “It’s the hidden tax hike that the Treasury loves so much, but hopefully, in his first full Budget, Kwasi Kwarteng will end their foolish fiscal love affair.”