Income tax receipts soared to an impressive £32.7 billion in July, marking the highest figure for that month since records began in 2008, according to the latest official data. This significant increase highlights the government’s reliance on revenue generated by freezing various tax thresholds for an extended period. The freeze on income tax and national insurance bands was initially implemented by Rishi Sunak in March 2021 during his time as chancellor. This decision effectively subjected workers to higher tax rates following pay increases, a situation known as “fiscal drag.” Jeremy Hunt later extended this freeze upon becoming chancellor.
Over the past year, income tax receipts totaled £281 billion, reflecting an 8% increase of £20.7 billion compared to the previous year, based on an analysis of HM Revenue & Customs data. The Labour government has not signaled any plans to raise the thresholds at which different income tax and national insurance rates apply. However, current chancellor Rachel Reeves has committed not to increase the headline rates of income tax, national insurance, or VAT.
The ratio of total tax income to gross domestic product, often referred to as the tax burden, is expected to reach its highest level in seven decades. As Reeves prepares for her first budget on October 30, there is speculation that she may consider adjustments to capital gains and inheritance tax.
The recent period of high wage inflation, driven by pay rises to address rising living costs, has significantly contributed to the increased tax revenue from fiscal drag. The Office for Budget Responsibility’s economic forecast in November 2023 estimated that this policy could result in an effective £44.6 billion tax hike over its lifetime and generate £13.6 billion more in revenues than previously projected. The spending watchdog also predicted that this policy would lead to nearly four million additional people paying income tax, with three million moving into the higher rate bracket and 400,000 more subject to the additional rate.
Currently, the first £12,570 of earnings are exempt from income tax, while earnings between that amount and £50,270 are taxed at 20%. A 40% tax applies to earnings from £50,270 up to £125,140, and any income above that level is subject to a 45% levy. As the government continues to depend heavily on revenue from frozen tax thresholds, the implications for taxpayers and the broader economy remain a topic of significant interest and debate among economists and policymakers.
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