In Focus: Tax Year End  

Inflation adds £12.5bn to govt's tax grab

Inflation adds £12.5bn to govt's tax grab

The government's tax rises from freezing income tax thresholds are £12.5bn higher than expected due to rising inflation.

Last year Chancellor Rishi Sunak announced a four-year freeze to income tax thresholds which, based on inflation forecasts at the time, was expected to represent a tax rise of £8bn.

But analysis from the IFS has shown the policy is now expected to represent a £20.5bn tax hike, compared with a policy of increasing thresholds with inflation, as inflation has risen sharply and is projected to rise even further.

The resulting potential tax take is on top of next month's National Insurance hike of 12.5 percentage points, which will bring in an extra £13bn.

The IFS warned the figures underlined the danger with freezing thresholds for long periods. 

Tom Waters, a senior research economist at the IFS, said: “Usually tax thresholds go up in line with inflation. Last March, when the chancellor announced a four-year freeze in income tax thresholds, inflation was fairly low and so he expected it to raise about £8bn per year.

"Since then inflation has risen rapidly and is expected to rise even further, peaking at more than 8 per cent. That means that the tax threshold freeze is now on track to be a £20.5bn tax hike – two and a half times what was originally expected.

"This episode highlights the danger with setting tax thresholds in nominal terms for long periods of time – unexpected changes in inflation can make the size of a planned tax rise much bigger or smaller than expected.”

Inflation rose to a 30-year high of 5.5 per cent in January and is expected to rise to close to 8 per cent next month. The ongoing war in Ukraine could put yet further pressure on inflation as widespread economic sanctions on Russia start to bite.

The Bank of America Merrill Lynch in its latest UK Economic Watch report forecast inflation to stay at 7 per cent for most of 2022, which it said would have to trigger the monetary policy committee into a series of rate rises.

The Bank of England had already raised its base rate to 0.5 per cent in February and today hiked it further to 0.75 per cent.

The bank's monetary policy committee said the impact of the war in Ukraine had "accentuated" both the peak in inflation, and the squeeze on household incomes.

It said it expects inflation to increase to about 8 per cent in the second quarter of the year, with the possibility of a higher rise at some point in 2022.

carmen.reichman@ft.com