Inflation is Sunak’s secret weapon as HMRC homes in on £1 trillion tax take for first time
A mixture of rising prices and ‘stealth taxes’ are helping the Chancellor to amass record revenues
Rishi Sunak has a secret weapon in his quest to restore the health of the country’s finances. While household budgets are being battered by prices rising at their fastest pace in 30 years, high inflation is helping the Exchequer net record tax revenues.
Figures from HMRC revealed yesterday that tax receipts in 2021-22 jumped to an all-time high of £718billion, almost a quarter up on a Covid-battered 2020-21.
Rising revenues on several fronts can be put down to the Chancellor’s “stealth” taxes and higher inflation. While families will undoubtedly have noticed this month’s National Insurance increase, households may not have spotted the tens of billions being taken from freezing thresholds on the likes of income and inheritance tax until 2026.
The tax-take boom is fuelling calls for the Chancellor to use his fiscal space to ease the pain families face this spring amid fears that the cost of living crisis will tip the economy into recession.
“The better-than-feared public finances have been driven by a revenue-rich recovery,” James Smith, research director at the Resolution Foundation, said.
“The tightest income squeeze in generations is upon us, and with the public finances in better shape than feared at the height of the pandemic the Chancellor can have little reason not to provide much-needed policy support to families.”
Revenues from taxes on inheritance, capital gains and income all jumped to record levels in the year to March 2022. Thanks to inflation, HMRC is expected to rake in more than
£1 trillion in receipts by 2025-26 for the first time.
This is partly a result of Mr Sunak’s stealth raid, known by economists as fiscal drag, which allows him to make more money through frozen thresholds as inflation and wage growth push taxpayers into higher tax brackets.
Typically, tax thresholds increase with inflation but now a worker earning just below the higher-rate band can be pushed above it even if their pay does not keep pace with prices.
Inflation also increases the take from many other taxes; for example, higher petrol prices will boost the amount of VAT revenue generated from fuel sales.
While inflation also helped to lift the government’s debt interest costs by £31billion in 2021-22, it was more than offset by the £134billion increase in tax revenues as the economy recovered and inflation picked up. The tax take was £6.5 billion more than the Office for Budget Responsibility (OBR) expected a month ago with inflation set to drive revenues even higher.
Martin Beck, chief economic adviser to the EY Item Club, said inflation
‘Income thresholds have been frozen in cash terms for four years so if inflation is more than expected that will magnify the revenue
‘With the public finances in better shape than feared, Rishi Sunak can have little reason not to give policy support to families’
would be a net positive for the country’s coffers, at least in the short term, as it boosted the size of cash receipts.
“The positives are you have a bigger nominal tax base so if prices in the shops are rising faster and people are carrying on spending then VAT revenues are going to be higher,” Mr Beck said.
“If wages respond to higher inflation by rising faster then that increases income tax receipts. And income thresholds have been frozen in cash terms for four years, so if inflation is higher than expected that is going to magnify the revenue gains from that.”
The crucial problem with Mr Sunak’s stealth tax tactic is that it is impossible for the Chancellor to know how much extra revenue he will suck from households.
Inflation was benign at 0.7 per cent when the policy was unveiled in March 2021 but it is now 7 per cent.
With the jobs market bouncing back quickly from the pandemic, income tax take jumped by 16 per cent on pre-covid levels to more than £220 billion in 2021-22.
The Institute for Fiscal Studies expects the impact of the frozen income tax thresholds pushing workers into higher brackets to raise an extra £21billion per year, far more than the £8billion expected when it was announced in March 2021.
Estimates suggest that more than 1 million extra workers will end up on the higher tax rate by 2026.
The inheritance tax take is also being boosted by frozen thresholds and house prices being pushed up by the property market boom, partly fuelled by the Chancellor’s stamp duty cut.
Revenues from the “death duty” hit a record £6.1billion in 2021-22 but the OBR expects receipts to surge to more than £8 billion in the coming years.
Tim Stovold, head of tax at Moore Kingston Smith, said: “It’s a very clear stealth tax. By freezing the inheritance tax allowance, more people are falling into the inheritance tax charge.
“Of the 14 per cent increase, I would say probably two thirds of that increase is down to more deaths and probably a third is down to the frozen thresholds.”
The bumper tax haul being netted by the Chancellor will embolden those calling for him to use his extra fiscal space to announce relief for families feeling the squeeze.
“Higher cash incomes and prices mean that households and businesses are still paying more in taxes than anticipated,” said Julian Jessop, economist at the Institute of Economic Affairs, on the buoyant tax revenues.
“This will give the Chancellor more room to help low-income families struggling with the cost of living without the need for additional increases in tax rates.”
Mr Sunak has resisted calls from Tory MPS to postpone this month’s NI hike but the pressure is mounting as his personal popularity nosedives.
His party is facing a difficult local election next month with tax rises and high inflation expected to cut real pay packets by 4 per cent this year. It will be one of the biggest annual drops since the Second World War.
The Chancellor was hoping to use his spending wriggle room for pre-election giveaways but, as tax revenues take off, he will find calls for immediate support growing louder.