UK Conservative party leader Liz Truss gave a surprisingly passionate moral defence of tax cuts this week but even the meagre tax cuts her government is delivering are cancelled out by considerable stealth tax rises caused by fiscal drag, a report has found.
For every one pound (£1) the average UK household will have extra from the high-profile tax cut the government announced two weeks ago, it will actually lose two pounds (£2) to so-called stealth taxes, a report by the Institute for Fiscal Studies (IFS) has said. The alarming findings indicate the great political theatre surrounding the cut in basic rate income tax by one penny in the pound (from 20% to 19%) is really an accounting trick masking the actual gains the government will make at the expense of households in the coming years caused by fiscal drag.
Fiscal drag is a function of governments setting absolute tax brackets but then not revising them with time, meaning a tax that may have once, decades ago, meant to only impact the very wealthy could in time hit the middle or even working class as inflation pushes salaries up. While a just and fair government would of course move taxation bands to account for inflation, they have a great incentive to not do so: by leaving banding frozen real tax takings rise without politicians having to take the reputational hit of having to announce new taxes.
As the IFS puts it in their report:
…freezes reduce household incomes and strengthen the public finances – all the more so in the high-inflation environment we currently find ourselves in. These freezes – which represent a stealthy and arbitrary way to raise tax revenue – often have a bigger impact on household incomes than more eye-catching discretionary measures… freezes reduce the transparency of tax and benefit reforms, allowing the size of the system to be changed by stealth.
In the United Kingdom, this effect has become extremely pronounced, with higher-rate tax bands very close to the same today as they were a decade ago. Even as far back as a Breitbart report in 2014, it was found a tax band created to punish the very wealthy but which hadn’t kept up with inflation was now carving out the earnings of upper-working and middle-class professions like school teachers and police officers.
Because this process happens passively and slowly over time, economists consider fiscal drag to be a stealth tax. It is generally — wrongly — something that is little discussed, but it has re-entered the political lexicon in recent weeks after the new government’s botched attempt to show it was pro-aspiration by cutting taxes, and then u-turning on parts of the idea.
The IFS report found that by not revising the level at which basic and then higher taxation begins on personal income the government is set to reap an additional £30 billion a year. An average household will see their actual income reduced by a considerable £1,250 a year by 2026 through this process, they said.
When that fiscal drag is added to other freezes, in effect the government’s new ‘tax cuts’ are being outweighed by hidden tax rises by a factor of two-to-one, leaving Britons considerably worse off.
The speed at which higher rate tax — again, introduced for the wealthy but slowly filtering down ever since — is clobbering the ‘squeezed middle’ middle classes is astonishing. While 3.6 million people were higher-rate taxpayers in 2014, the IFS report estimates with these band freezes that number will continue to rise to a staggering 7.7 million by 2026.
A report in The Times reports what when approached for comment on the subject, a treasury spokesman gave a nice sounding but — in light of the impacts of fiscal drag — totally hollow reply of: “Helping people to keep more of their hard-earned money is a key priority.”
These revelations, clear for years but placed into the starkest relief by the production of alarming estimates in the reports, come only a day after the UK’s new Prime Minister Liz Truss gave one of the most steadfast-sounding defences of tax-cutting by a Conservative leader in a generation.
While the words were strong, the considerable degree to which they appear to be mere theatre to distract from the fact the new Chancellor has decided not to reverse the previous government’s imposition of tax band freezes will leave conservatives disappointed. As reported yesterday, Truss spoke at the annual Conservative Party conference in Birmingham and portrayed tax cuts as a moral imperative. She said:
Cutting taxes is the right thing to do morally and economically. Morally, because the state doesn’t spend its own money. It spends the people’s money. Economically, because if people keep more of their own money, they are inspired to do more of what they do best. And that’s what grows the economy. When the government plays too big of a role, people feel smaller. High taxes means it feels less worthwhile, working that extra hour, going for a better job, or setting up your own business.
…I remember my shock, opening my first paycheck, seeing how much the tax man had taken out. I know this feeling replicated across the country!
There are only little more than two years to go until the next UK general election, by which time Truss will have had to convince would-be voters that she means what she says, or not.