Millions of British workers could face a stealth income tax raid this month as Rachel Reeves' is at risk of breaking her tight fiscal rules, warns the Institute for Fiscal Studies (IFS).
It comes as the Office for Budget Responsibility (OBR) is expected to report that the £9.9billion fiscal headroom afforded by the Chancellor's Autumn budget has now evaporated due to sluggish growth, higher inflation (recently hitting three per cent) and increased government borrowing costs.
This has meant Reeves's commitment to borrowing only for investment purposes and reducing debt as a percentage of GDP has left her with limited flexibility in the budget.
Matthew Oulton, of the IFS, said: “Rachel Reeves has engineered a trap for herself, albeit in difficult circumstances. Aiming to meet inflexible, pass-fail fiscal targets by the slimmest of margins was a risky strategy from the outset.
“It was always possible that economic conditions would deteriorate, put her on track to miss those rules, and push her into making tax and spending changes at what isn’t supposed to be a fiscal event later this month.”
Millions of British workers could face a stealth income tax raid this month as Rachel Reeves' is at risk of breaking her tight fiscal rules
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Stealth tax raid
To plug the fiscal gap, the government might consider extending the freeze on income tax thresholds beyond 2028. This measure could generate approximately £10billion in additional revenue by 2029-2030, according to an analysis by IFS.
Extending the freeze on income tax thresholds means that as wages rise due to inflation or career progression, more individuals could move into higher tax brackets—a phenomenon known as "fiscal drag". This effectively increases the tax burden without altering tax rates.
This could leave millions of workers with less disposable income, hitting demand for goods and personal savings.
According to Vicky Pryce, the chairman of the BCC Economic Advisory Council, this would compound an already bleak economic outlook.
She said: “We’ve seen very little growth in the private sector. There is a general malaise. People are being very careful both on the spending side, and on companies’ willingness to invest or grow. We are seeing demand slowing down.”
Lower earners see smaller increases, while higher earners face significantly larger tax burdens as a result of stealth tax raid
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How much could more could you be expected to be pay
As the graph above shows, lower earners would see smaller increases, while higher earners face significantly larger tax burdens.
A worker on around £20,000 could owe the taxman £250 more annually by 2029 if the freeze continues.
A worker earning £35,000 today could pay around £500 more annually.
A £50,000 earner might pay around £1,000 extra due to fiscal drag, with those earning £150,000 potentially paying around £6,000 extra.
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The alternative scenario
To avoid increasing taxes, the government might opt for spending cuts or allow inflation to reduce the real value of public spending. This could result in reduced funding for public services and potential freezes or reductions in welfare benefits.
However, the danger signs are everywhere in the economy, according to Tim Moore at S&P Global Market Intelligence.
“Worries about the near-term economic outlook and the impact of rising payroll costs contributed to another slide in business optimism,” he said.
“Less upbeat business expectations and another month of sharply rising input prices led to net job shedding across the service economy in February. Employment has now decreased for five months in a row. Aside from the pandemic, this represents the longest period of falling employment since early 2011.”
A Government spokesman said: “The Government’s commitment to fiscal rules and sound public finances is non-negotiable. As previously announced, the OBR’s next forecast will be presented to Parliament on 26 March alongside a statement from the Chancellor. We do not comment on speculation around OBR forecasts.”
