The UK Treasury has a number of institutional biases (what other people call prejudices). They tend to disbelieve any evidence that tax cuts cause growth, no matter how respected the study. Their forecasting record might euphemistically be described as patchy and their offspring – the Office of Budget Responsibility – seems to have inherited this trait, which is partly a consequence of a very complex modelling system that is hard to unravel or short circuit. And they love stealth taxes, the quintessential means of achieving what Louis XIV’s finance minister Colbert meant when he wrote that ‘the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.’ Not all their biases are bad. Most particularly they have a strong belief in the need to sustain the public finances, which in the 1970s helped the country to recover from having to put itself in the hands of the IMF – the national equivalent of bankruptcy, and they also have a remarkable ability to act quickly, as they did with the furlough scheme during the pandemic which emerged in days (though I suspect they were very long days).

Every so often two of their prejudices combine together to produce an unwanted effect and in this case the freezing of tax allowances and upper rate thresholds in the March 2021 Budget as a stealth tax has combined with bad forecasting of inflation to mean that by the fiscal year 2025/26 the number of people paying tax, which was 32.2 million in 2021/22, could rise by 5 million and perhaps even more damagingly the number of people paying higher rate tax at 40% will virtually double from 4.1 million to 8.1 million. This is a £40 billion tax rise originally planned to raise £8.2 billion.

The revenue likely to be raised by the freezing of tax allowances and thresholds is in fact twice as large as the £20 billion to be raised by NI rises announced as the Health and Social Care Levy which has proved controversial. But at least the Health and Social Care levy was announced and voted through Parliament. The impact of unexpected (at least by the Treasury) inflation on the freezing of allowances and bands was not voted for.

On the whole this is not a good tax. There is a case for reversing the policy of the Coalition government which reduced the number of taxpayers by 2 million by raising tax allowances. On the one hand it helped make a lot of part time jobs economic. On the other it, together with changes in the distribution of income, helped foster a belief that tax is something that other people pay – a third of income tax is now paid by only one per cent of taxpayers. Such a belief is likely to bias electoral behaviour in favour of high tax and high spend. But the doubling of the number on higher rate tax will have economic consequences which will be largely negative. Already the student loan thresholds are discouraging young people from taking high productivity jobs and this will add to the consequences of that policy error.

We ran the forecasts for this on a fairly strong but not implausible forecast for wage inflation – average incomes rising at an annual rate of 6% for 3 years and then gradually subsiding to 4% in the following two years. But even assuming 4% wage rises, which now is at the low end of the range of expectations, the unanticipated inflation raises £20 billion from the freezing of allowances and rates, brings 2.9 million into the tax net and raises the number of higher rate taxpayers from 4.1 million to 6.2 million.

My guess is that the Chancellor will plan to spend the revenues raised from this stealth tax by cutting other taxes. But using stealth taxes to pay for cuts in other taxes is an extreme version of bribing us with our own money.

For more information please contact: 

Douglas McWilliams dmcwilliams@cebr.com phone: 07710 083652