Sunak’s tax freeze nets UK government £40bn bonus

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The extra tax haul from Rishi Sunak’s multiyear freeze to income tax allowances and thresholds is set to reach £40bn a year by 2028 because of stubborn inflation — £10bn more than estimated just a few months ago — according to research.

The calculation by the Resolution Foundation think-tank for the Financial Times demonstrates how the prime minister is quietly securing vastly higher tax revenues from the public through a process called “fiscal drag”.

When the Treasury freezes income tax thresholds while people’s salaries are growing, as they are doing amid the highest inflation for a generation, its revenues increase.

“Abandoning the usual uprating of tax thresholds is a tried and tested way governments of all stripes raise revenues in a stealthy way. But it is the far bigger than anticipated scale of the government’s £40bn stealth tax rise that stands out,” said Adam Corlett, principal economist at the Resolution Foundation.

He added that any talk of tax cuts ahead of next year’s election should be seen in the wider context of these huge stealth tax rises.

Sunak was chancellor in 2021 when he first announced a four-year freeze in income tax allowances and thresholds along with freezes to inheritance tax and National Insurance thresholds.

At the time, the Treasury expected the move to raise £8bn a year by 2026. But by the 2022 spring Budget, the Office for Budget Responsibility, the fiscal watchdog, had revised the annual figure upwards to £18bn due to inflation. 

In March this year the OBR further lifted the estimate to £29bn a year, equivalent to a 4p rise in the headline rate of income tax, from 2028. That partly reflected inflation but also the fact that Chancellor Jeremy Hunt last autumn extended the thresholds freeze for two years. 

The relentless rise of inflation has pushed up the number of people who will be sucked into higher income tax brackets and of low earners forced to pay the levy for the first time. 

The Resolution Foundation estimates that fiscal drag will deliver £40bn a year by the end of the freeze in 2028, Britain’s biggest income tax rise in at least half a century. 

At the time of the Budget in March, the OBR expected inflation to drop to 5.4 per cent by September 2023, the point at which tax thresholds are usually uprated in the following tax year. But the latest Bank of England forecast from August pointed to a rate of 6.9 per cent for September.

The BoE has also recently forecast a total of 6 per cent inflation from the third quarter of 2023 to the third quarter of 2026 — compared with the OBR spring forecast of just 1 per cent in that period.

“At the time of the Budget in March, this policy was set to raise £30bn in 2027-28 — already vastly more than originally forecast,” the Resolution Foundation said. “But using the Bank’s latest inflation forecasts, the Foundation calculates that the policy will now raise £40bn a year by the time it is fully rolled out in 2027-28.”

People start paying income tax when they are paid £12,570 a year — a figure that will stay the same until April 2028. If that threshold was uprated by the inflation rate expected over this period it would rise to about £16,200.

Ruth Gregory, deputy UK chief economist at consultancy Capital Economics, said the foundation’s “credible” calculations suggest the chancellor has more headroom against his main fiscal mandate, which requires him to ensure underlying debt as a share of GDP is falling in five years’ time.

If the policies were to raise £40bn a year by 2027-28, rather than £29.3bn as the OBR predicted in March, this would add about £11bn to the £6.5bn headroom the chancellor has against his main fiscal mandate, she said. 

However, she added that higher inflation would feed through to the government’s borrowing costs. “Set against that, since March, market rate expectations and longer-dated gilt yields have risen, which will feed directly into higher debt servicing costs.”

A Treasury spokesperson said the government was determined to halve inflation rather than borrow money to fund tax cuts.

“We have also taken 3mn people out of paying tax altogether since 2010 through raising personal thresholds, and the chancellor has said he wants to lower the tax burden further — but has been clear that sound money must come first.”