Could Fiscal Drag Become a Political Drag?

In today’s autumn statement, the chancellor announced a reduction in National Insurance. This means a tax cut for 36 million people. 

Yet, critics argue that the freezing of the personal allowances in a period of high inflation means that overall people will continue to see taxes rise.

It is fair to say Jeremy Hunt is not the first Chancellor to give with one tax cut and take with the other. Yet understanding today’s tax cuts and the long-term freezing of the personal allowance is crucial to analysing today’s budget and the broader politics of tax in the coming years.

What is the personal allowance, and why does it matter to all of us?

The personal allowance is the amount we can earn before paying income tax. It’s currently set at £12,571 with a reduction for those earning over £100,000. Until recently, the personal allowance had risen with inflation, but in 2021, the then Chancellor Rishi Sunak froze the personal allowance – a policy continued by the current Chancellor, Jeremy Hunt. 

This has led to more taxes being taken from more voters – it's what experts call fiscal drag. And, when combined with rising wages as the result of inflation, it is the major reason the Treasury is seeing significant increases in tax intake. 

That means even with today's changes, taxes remain high for most voters, as UCL Policy Lab Honorary Professor and IFS Director Paul Johnson pointed out on X "Taxes on income and earnings are still much higher than three years ago. The NI changes undoes only a small fraction of the huge tax increase resulting from the freezing of income tax allowances and thresholds".

It was a point made by UCL Policy Lab Honorary Professor Torsten Bell in a recent report from the Resolution Foundation. The Resolution Foundation has predicted that if the government keeps freezing the personal allowance, it would mean basic rate taxpayers will be paying an additional £720 a year.

What about today’s tax cut?

With today’s cut to National Insurance, Jeremy Hunt will hope that voters will start to feel the benefits ahead of next year’s general election.  

This is a major move in the government’s strategy for re-election. And, on the surface, seems a sure-fire vote winner.

But according to research by UCL’s Professor Lucy Barnes, the politics may seem deceptively straightforward.

“Cuts to basic rates of tax are broadly popular, and so we can see why the government might choose to take today’s course of action.” 

And yet, Barnes explains, this does not mean that voters are not aware of the wider tax changes. 

As many voters will continue to see high and increasing levels of personal taxation, Barnes points out the government may not receive much thanks for the changes it’s made. 

Indeed, they might prefer different courses of action.

“What is also true is that using the £7bn to unfreeze personal allowance is actually marginally more popular than the option taken by the Chancellor.”

As well as being marginally more popular, it is, according to Torsten Bell, preferable in terms of fairness, as it would provide more significant benefits to those on the lowest incomes.

The Chancellor’s decisions do, however, also deliver a long-term challenge for Labour. 

If the party goes on to win the next election, they will then have a choice as to whether they uprate the personal allowance or perhaps focus their firepower on spending. 

In truth, what economists call fiscal drag may also mean a political drag for the government and a long-term headache for whoever wins the next general election. 

Finally, all of today's announcements are only possible due to the additional 'fiscal headroom' - extra funds found from taxation or spending decisions. And although there is good news for the government, as UCL Policy Lab Honorary Professor Chris Giles made clear most of these additional savings are down to public spending not keeping up with inflation. 

In recent years Britain has increased taxes for those in work. This may well be popular – or at least acceptable – to many, if it is seen to underpin significant improvements in public services and long-term investment. But it has opened up new lines of tension at the heart of British politics. How that tension is resolved, and what it means for fairness in the economy, will have major implications for the political battle for years to come. 

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