Hunt raid risks cycle of higher taxes for a generation

Stealth swoop on earnings threatens to cost the average household £1,000 as policy on thresholds is rewritten, says Tim Wallace

An era of rising tax thresholds ushered in by George Osborne will be further consigned to the history books this week as Jeremy Hunt confirms a stealth raid to plug the hole in government finances.

A four-year freeze to the income tax threshold has already been announced and the Chancellor is thought to be looking at extending that for another two years to 2028.

Hunt and allies believe the raid is necessary to plug the multibillionpound hole in government finances but those on the pro-growth wing of the party fear it could doom Britain to a self-perpetuating cycle of higher taxes.

“That is the risk you take by raising taxes at this point in the cycle – that you never get out of it,” says Jacob ReesMogg, the former business secretary.

“The economy shrinks, you raise taxes more to try to fill the hole, the economy shrinks more, and you are constantly raising taxes to deal with the shrinking economy.”

Chris Etherington, at RSM, expects “a supermarket sweep of freezing any and every tax allowance and threshold” in Thursday’s Autumn Statement , as the Chancellor seeks to plug a black hole of between £50bn and £60bn in public finances.

“That means inheritance tax, capital gains tax, pensions, income tax, National Insurance – all of these thresholds are set to be frozen, and some may be halved with more people being dragged into the tax net or higher tax rates as a result,” he says.

It was not supposed to be like this. The 2019 Conservative manifesto promised a “low tax economy” with no income tax, National Insurance or VAT increases and strong economic growth to pay for public services.

However, the Government’s finances have taken a beating since then. First the pandemic, then the underwhelming economic recovery and now the energy crisis have led to soaring costs and debt at a time of weak tax take.

Still, the last chancellor battling to repair public finances took a very different stance to tax thresholds compared with Hunt.

George Osborne’s Budgets were not known for their generosity, given his focus on cutting the deficit after the debt binge of the financial crisis but some people certainly did benefit after the former chancellor enthusiastically adopted a key tax policy first proposed by coalition partners the Lib Dems. Osborne raised the point at which workers start to pay income tax, so that by 2016 he could boast: “A typical basic rate taxpayer will be paying over £1,000 less income tax than five years ago. And it means another 1.3m of the lowest paid taken out of tax altogether.”

The tax-free allowance surged from just under £6,500 in 2009-10 to £10,600 by 2015-16 and £12,570 last year. The rising income tax allowance provided a boost to all workers but particularly those on lower incomes. The policy helped boost living standards by letting people keep more of their earnings.

Now, this era of rising thresholds is at an end. “Over the last 30 years, it is fair to say the UK has been one of the low-tax nations compared to the other OECD countries,” says Etherington.

“Such claims could now be shortlived. It is likely we are going to climb the ranks of the tax league table. The UK is fast becoming a high-tax nation and looks set to stay that way. There will be plenty of tax pain to share around.”

Hunt’s planned stealth tax raids are especially painful at a time of rising inflation. The £12,570 that an employee takes home tax free today is worth significantly less now in real terms than it was a year ago given prices are rising by more than 10pc.

As pay rises accelerate to try to keep pace with inflation, the Treasury could reap a total of £27bn from a range of stealth taxes, at a cost of £1,000 to the average family, the CEBR has calculated. This process is known as fiscal drag, whereby rising wages pull more people into higher tax brackets or taxes altogether.

The technique of stealth taxes is not new – Labour leader John Smith denounced a two-year threshold freeze in 1993 as “a devious way” to “try to increase the income tax bill without the public detecting they are putting it up”.

Fiscal drag means the freeze will take the threshold back to just below its 2013-14 level in real terms, according to Carl Emmerson, at the Institute for Fiscal Studies. “That is a long freeze and it is reversing a lot, but not quite all, of the increase we have seen since Conservative prime ministers took office in 2010,” he says.

As freezes are extended, it looks less likely they will ever be reversed. Even linking the tax-free income allowance to inflation in future would lock in the real-terms cuts imposed by current freezes. Worse still, the imminent rise in taxes is not only a temporary phenomenon but is expected to stay for

‘That is the risk you take by raising taxes at this point in the cycle – that you never get out of it’

‘You have to do everything you can to try to get the economy growing faster’

years to come. Rishi Sunak’s Health and Social Care Levy, which began with the now-cancelled National Insurance increase, aimed to raise £12bn or more each year to pump into the NHS to clear Covid backlogs. Those have not gone away and demand will only grow as the population ages. This was a key hazard set out in the Office for Budget Responsibility’s fiscal risks report.

Pressure is growing in other parts of the public sector, with state employees’ pay lagging behind both inflation and rises in the private sector. Large-scale strike action shows tensions are reaching boiling point – and action to satisfy unions will be expensive.

Emmerson says spending pressures are spreading, noting that even if Liz Truss’s plan to boost defence to 3pc of GDP is dropped, other Nato countries are increasing their budgets in response to Russia’s invasion of Ukraine, which will encourage Britain to do the same.

Even before next week’s likely increases, IFS figures show the tax burden is already on course to rise to around 36pc of GDP, a level not sustained since the 1950s.

Economists who back lower taxes as a way to boost growth are in despair.

Tom Clougherty, head of tax at the Centre for Policy Studies, which was instrumental in writing the Conservatives 2019 low-tax manifesto, says it is “pretty clear we are on a grim trajectory” of rising taxes to pay for ever more expensive public services.

“The post-war welfare state is going to become more expensive because the population is ageing,” he says.

Paying for that requires either heavy borrowing, which is currently unattractive given rising rates, cutting non-health and pensions spending, raising taxes, or growing the tax base by boosting the economy. “You have to do everything you can to try to get the economy growing faster,” says Clougherty.

“We are in an unfortunate situation where the main thing any government could do is not around tax or regulation, but it is around infrastructure and housing and the fact it is so impossible to build anything in this country.

“So you have Conservatives who would rather raise taxes – something most ideological conservatives think runs completely against their principles and philosophy – than take on Nimbyism or work around Nimbyism to get things built,” he says, referring to the acronym “not in my back yard”, or Nimby, for those who oppose construction projects.

Until that changes, Britain appears destined for more spending cuts and tax rises. Osborne’s austerity might just have been the start of a long squeeze – not just a temporary blip after the financial crisis.