The UK chancellor Rishi Sunak has faced a rapid backlash, even from some in his own party, for failing to do enough to help the poorest households cope with rapidly rising prices. The danger for the Conservative government is that a large portion of the public may, over time, become increasingly disillusioned with the effects of this week’s Spring Statement. It was presented as a tax-cutting moment — reducing fuel duty by 5p a litre and raising the salary threshold at which workers start paying National Insurance. In reality, the impact of inflation while most tax thresholds remain on hold means the exchequer will be taking ever more from people’s pay cheques. The impact of what is known as fiscal drag — in effect, stealth taxes — will soon start to be felt.
As tax brackets are usually fixed in cash terms — the UK basic rate income tax rate of 20 per cent is replaced by a higher rate of 40 per cent for pay above about £50,000 and 45 per cent above £150,000 — higher inflation means more taxpayers are dragged into these higher bands, especially if finance ministers are slow to update the brackets. Last year, the chancellor froze these thresholds and according to the Institute for Fiscal Studies, a think-tank, higher than expected price rises have “magically doubled” the additional revenue the freeze will raise.
For benefits claimants, a similar logic applies. State pensions and universal credit are increased annually by the rate of inflation, but only in the autumn — which is likely to be after this year’s peak of price rises has passed. That helps the public finances, but at the expense of the spending power of many less well-off households. Departmental spending settlements, negotiated between the Treasury and other ministries, are fixed in cash terms too. Without a renegotiation, inflation reduces how much the chancellor’s colleagues have to spend, in real terms, on public services.
Criticism of stealth taxes can be overdone. They can be a prudent source of much-needed cash for governments that must find ways to raise revenue without irritating taxpayers too much. Indeed, the rise in inflation will help to reclaim much of the cost of coronavirus support schemes to the public purse. Bonds, too, are usually not indexed to inflation, so rising prices can reduce the burden of government debt relative to national income. Relying on inflation to reduce the real value of government debts is the oldest fiscal trick in the book, practised by Roman emperors and medieval kings as well as modern-day finance ministers, for good reason.
Yet with widespread reporting of 9 per cent inflation forecasts for later in the year there is little stealthy about such stealth taxes. Few Britons will fail to notice that their wages no longer pay for what they used to. Any windfall for the public finances that Sunak wants to bank today to fund bigger crowd-pleasing tax cuts before the next general election is, ultimately, a transfer from taxpayers now, at a time when the cost of living is rising dramatically.
Fiscal drag might be a reasonable, if underhand, strategy when growth is strong and real incomes are steadily rising, but that is not what the UK is facing. Nor can the smoke and mirrors obscure the long-term challenge for Britain’s public finances. The country is approaching the middle of its second “lost decade” of economic growth. The tax burden is rising, even with Sunak’s recent cuts, to the highest level since the end of the second world war, and the demands on the exchequer to spend even more on public services will not end. Britons will have to pay more tax on their barely-growing incomes. There is no disguising that fact.