Frozen allowances and falling thresholds could see 1.5 million people creep into a higher tax bracket by 2027. Professional Adviser reports that around 300,000 of these will become additional-rate taxpayers.
Rising tax receipts are great news for the Treasury in the short term. In the longer term, though – with inflation high and incomes rising – higher tax bills will ultimately lead to less money in Brits’ pockets.
When higher taxes (whether through genuine rate rises or the stealth taxes of recent years) lead to a drop in consumer spending, the effects can be deflationary. This is known as “fiscal drag”.
Keep reading to find out what Jeremy Hunt’s current policy will mean for your tax bill over the next few years.
2 key factors are helping to increase the amount of tax you pay
1. Frozen tax allowances and thresholds
Rishi Sunak used his 2021 spring Budget to freeze several allowance thresholds. In 2022, Jeremy Hunt extended some of them until the 2027/28 tax year.
The Personal Allowance
The Income Tax Personal Allowance is the amount you can typically earn before paying Income Tax. Jeremy Hunt froze this at its current level (£12,570) until 2028. He also extended the freeze to the higher-rate threshold (£50,270) and the National Insurance thresholds, all to 2028.
Hunt reduced the threshold for additional-rate taxpayers from £150,000 down to £125,140. Earnings above the new, lower amount will be subject to Income Tax at 45%.
Inheritance Tax thresholds
The Inheritance Tax (IHT) nil-rate band has sat at £325,000 since April 2009. The residence nil-rate band threshold is currently £175,000. While both IHT thresholds were already frozen until 2026, that freeze is now in place until at least 2028.
Professional Adviser confirms that the Office for Budget Responsibility (OBR) expects IHT receipts to soar in that time, from £6.1 billion in 2021/22 to £7.8 billion by 2028.
2. High inflation might have peaked but it could fall slowly
Inflation first crept above the Bank of England’s (BoE) 2% target in May 2021, as coronavirus restrictions eased and UK consumers emerged from lockdown eager to spend their “accidental” savings.
Since then the general trend of the Consumer Price Index (CPI) has been upward. It eventually peaked in October at a massive 11.1%. The figure marked a 41-year high.
While inflation is now expected to fall, it won’t do so sharply until later in the year.
When the BoE announced its latest rise to the base rate (a tool intended to curb high inflation), the Monetary Policy Committee acknowledged that professional forecasters didn’t expect inflation to return to the BoE’s 2% target for another three years.
High inflation raises the cost of living and wage increases are needed to keep up. While wage growth still lags behind inflation, static tax thresholds mean the pay rises will be pushing UK workers into higher tax brackets.
Higher tax burdens for consumers could influence the economy
With inflation high, the cost of living crisis continues.
The International Monetary Fund (IMF) forecasts that the UK will be the only developed economy to shrink this year. It’s worth noting that recessions often lead to rising unemployment.
According to MoneyWeek, unemployment in the UK is expected to rise to 4.1% by late 2023. The Guardian, meanwhile, confirms that the number of people looking for work is rising, while the number of job vacancies is falling.
As the current cycle looks set to continue into 2023, slow economic growth, rising unemployment, and a high CPI all point toward a period of stagflation.
While the BoE has responded by increasing its base rate (for 10 consecutive meetings), this has increased the cost of borrowing and added to household woes. With tax thresholds frozen, or even falling, your taxes will rise and this “drag” could mean that you need to revisit your long-term plans. That’s where HA&W come in.
Get in touch
If you worry the government’s current policy of tax stealth through frozen allowances could upset your financial plans, get in touch.
We can revisit your plans and your budget to make sure you are still on track, providing reassurance whatever the outcome. Contact us now to find out how our Chartered financial planners could help you.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
