As all our readers will know, the new Chancellor, Jeremy Hunt, delivered his Autumn Statement on November 17th.
It had been widely predicted ahead of the speech that Hunt would freeze tax thresholds and this proved to be the case – prompting a great many commentators to talk about how we’d all be paying more tax, thanks to something called ‘fiscal drag.’
So what is fiscal drag – and what does it mean in real terms?
Fiscal drag is an economic term, meaning that inflation and/or income growth moves taxpayers into higher tax brackets. This increases government tax revenue – but still allows politicians to claim, ‘we haven’t put taxes up.’
Let’s take a very simple example. Higher rate tax in the UK is payable on amounts earned over £50,270. Assume your salary is £48,000: if you receive a 5% pay rise this year (well below the current rate of inflation) your salary will be £50,400 – taking you just into the higher rate band. Another 5% pay rise next year takes you to £52,920 – with all of your pay increase taxed at the higher rate.
Jeremy Hunt faced a difficult task in the Autumn Statement as he looked to plug a hole in the public finances of between £50bn and £60bn, depending on which paper you read. The decision to freeze income tax thresholds – already frozen until 2026 under the previous Chancellor – to 2027/28 had been widely trailed, with the Institute for Fiscal Studies predicting the move could raise £30bn due to the current high inflation.
But it is not these overall, macro-economic sums that will worry people – rather the simple question of how much extra tax they will pay. One firm of financial advisers has calculated that the biggest squeeze will be faced by middle earners, with those on a salary of £50,000 due to pay an extra £6,570 in income tax over the period, compared to a system in which tax thresholds matched inflation.
Average earners – those on a salary of £33,000 – will end up paying an extra £2,557, an increase in tax paid of approximately 10%.
For the vast majority of people, the figures will be significant: they’re a family holiday, a deposit on a new car, perhaps money they’d give to their children towards their first house.
That’s why it is called ‘fiscal drag.’ The increase in taxes reduces overall consumer spending, because a larger share of consumers’ income is now going in taxes. With less money to spend, this leads to deflationary pressures – or drag – on the economy.
The Chancellor also cut the figure at which higher earners pay the top rate of tax from £150,000 to £125,140 – and extended the freeze on the inheritance tax threshold for a further two years. Taking all these measures together, one thing is crystal clear after the Autumn Statement: the need for first class, long-term, tax-efficient financial planning has never been greater.
Our commitment to providing this level of financial planning has never wavered. Whether it is planning your pensions and ISAs, making use of all your available tax allowances, or ensuring that your estate pays as little inheritance tax as possible then – as all our clients know – we are ready and able to help.
What is fiscal drag https://www.investopedia.com/terms/f/fiscal-drag.asp