More than one million people are set to be dragged into the higher rate tax band by 2026, with economists warning that Britain is facing the biggest cost of living crisis for a generation.
The Treasury’s plan to freeze income tax thresholds – which comes at a time of rapid wage and price inflation – will push more than 1.2 million workers’ earnings above the 40p threshold in the next four years, according to analysis by the House of Commons Library.
The research emerged as the Government faces criticism over its handling of the cost of living squeeze facing families, with energy bills set to soar as a planned increase to National Insurance Contributions (NIC) looms in April.
A Cabinet rift erupted this week when Jacob Rees-Mogg urged Rishi Sunak, the Chancellor, to halt the planned NIC rise to alleviate the burden facing struggling households.
The demand was echoed by Tory MPs, who also urged the Government to "rethink" the plan to freeze income tax thresholds and called for VAT on energy bills to be scrapped.
Rising cost of living for longer
On Thursday, Mr Sunak said he would not "duck difficult decisions", adding that he understood public "anxiety and concern about rising prices and inflation" but arguing that the NIC increase was necessary to tackle the backlog in the NHS caused by Covid.
On Thursday night, economic experts issued warnings about the pressures facing families struggling with the rocketing cost of living.
Paul Johnson, the director of the Institute for Fiscal Studies (IFS), said people faced a squeeze this year that "could well be worse than the financial crisis".
His concerns were echoed by business leaders including Lord Wolfson, the chief executive of Next, and Sir Howard Davies, the Natwest chairman, who said he feared ministers may struggle to keep control of the public finances as prices surge.
Torsten Bell, the chief executive of the Resolution Foundation think tank, said: "April in particular is going to be a cost of living catastrophe, and the year as a whole will be defined by the squeeze."
The Government’s decision to freeze income tax thresholds rather than raising them in line with inflation is set to affect more households and cost them more in tax than initially estimated when the plan was announced last spring, with inflation climbing much faster than expected.
Wage growth risk falling behind inflation
The House of Commons Library analysis, commissioned by the Liberal Democrats, found that an extra 1.2 million people will be driven into the the 40p higher rate tax band – which starts at £50,070 – by 2026 than if the Government were to raise that threshold in line with forecast inflation to £56,270.
Meanwhile, an extra 1.5 million low paid earners will be pushed into the 20p basic tax rate, which starts at £12,570, than if the personal allowance threshold rose in line with forecast inflation to £14,070 over the next four years.
These income tax threshold freezes, lambasted as a stealth tax raid, will collectively cost families in England, Wales and Northern Ireland almost £11 billion by 2026, the research found. The policy is forecast to cost the average household an extra £430 a year by then.
On Thursday night, both Conservative and opposition MPs demanded that ministers re-examine the plan. Tory Jake Berry, the chairman of the Northern Research Group, urged Mr Sunak to "think again" about raising the thresholds.
Christine Jardine, the Lib Dem Treasury spokesman, called on the Government to "drop this unfair stealth tax that will clobber families who are already feeling the pinch".
It comes on top of a bleak start to 2021. Inflation is already running at 5.1 per cent, its highest level in a decade, and is expected to climb above six per cent within months as goods and services become more expensive.
In April, households will be hit by an increase of as much as 56 per cent in their energy bills when the price cap is increased to take account of a huge jump in the cost of wholesale gas. Calculations from Investec, the investment bank, suggest the typical energy bill will go up from £1,277 to almost £2,000 a year.
Energy bills are heating up
An increase in national insurance of 1.25 percentage points will kick in in the same month, costing the average worker £255 a year.
Mr Johnson, the IFS director, said: "If you are someone on average earnings who is going to be hit by a tax rise as a result of the reduction of the personal allowance, and a tax rise because of national insurance, and an extra potential several hundreds pounds a year from fuel prices, then this could well be worse than the financial crisis.
"There’s going to be inflation of six or seven per cent and earnings not going up anywhere near that fast – so put those two things together and I find it hard to think of a March-April period which will have been quite so bad. This is a combination of a big tax rise and falling real earnings. It’s not pretty."
Mr Bell said a bigger hit to household incomes than caused by the financial crisis was "definitely realistic".
Businesses are increasingly concerned. Next said the tax increase may "affect discretionary spending", and Lord Wolfson said: "By increasing wages, one industry steals from another. We have increased wages in the areas where we have shortages of supply, but all that does increase pressure on other industries."
He said Next is putting up its own selling prices by an estimated six per cent.
Rising inflation also poses a threat to the Treasury’s coffers by pushing up the amount of money Britain must pay on servicing its national debt of more than £2 trillion.
Speaking to Bloomberg, Sir Howard, the Natwest chairman, said: "My biggest worry is whether the Government can stabilise the national finances. I think this is a delicate thing and that’s why the Treasury is, as we understand it, staying firm."
A government spokesman said: "The UK has the highest basic personal tax allowance in the G20 – and maintaining the threshold is a progressive approach to fund our world leading public services and rebuild the public finances following Covid.
"Higher earners will continue to contribute more, and nobody’s take-home pay will be less than it is now in cash terms."