Families will pay an extra £30bn a year in tax as soaring inflation drags millions of people into higher income tax bands, according to a leading think-tank.
Rising prices and former chancellor Rishi Sunak’s freeze on tax thresholds has left workers facing a stealth raid on their earnings, the Institute for Fiscal Studies (IFS) said.
The change is due to so-called “fiscal drag”, which pushes people into higher income tax brackets as pay rises.
Tax allowances usually rise in line with inflation but were frozen last year by Mr Sunak until 2026.
The £30bn in extra income tax is almost four times as much as the Government was originally expected to raise from Mr Sunak’s policy and will wipe out any gains from tax cuts promised by leadership frontrunner Liz Truss.
Ms Truss has pledged to reverse a £14bn rise in National Insurance (NI) contributions introduced by her rival.
Paul Johnson, director of the IFS, said: “Even if the new prime minister were to undo the [NI] rise, overall taxes on income would still rise under current policy.”
Both Tory leadership hopefuls are under mounting pressure to reveal more financial support for households facing energy bills of more than £4,200 this winter. The IFS said addressing Mr Sunak’s stealth tax would do more to boost incomes than cutting headline tax rates.
“By cutting the rate of national insurance contributions, while simultaneously raising tens of billions more than initially expected from a freeze in income tax thresholds, the Treasury would effectively be giving with one hand while taking with the other,” said Ben Zaranko, IFS senior economist.
He added: “If seeking to help low-to-middle income households through the tax system, it would make far more sense to increase thresholds, rather than cut rates.”
Ms Truss is expected to hold an emergency budget and spending review
Mr Sunak said tackling “pernicious” inflation, which the Bank of England expects to hit 13.3pc this Autumn, remained his number one goal. A spokesman said: “Rishi’s priority is to grip inflation, grow the economy and then cut taxes.”
The IFS warned that rising prices would also squeeze Government spending across Whitehall and the NHS.
Rising prices have delivered an “unintended dose of austerity” that will wipe out 40pc of planned spending increases on public services, the think tank said. Spending plans announced less than a year ago are now “considerably less generous” because budgets are set in cash terms.
The Treasury would need to top up spending by more than £18bn a year by the end of the current parliament in 2025 to compensate for the squeeze, the IFS calculated.
Mr Zaranko said: “There are some tough choices to be made. Do they cut back on headcount, do they provide worse services to communities. In terms of the NHS, do they delay setting up hospitals? Or throw back waiting list times? Higher inflation means the reality is the same amount of money just doesn’t go as far.”
IFS analysis showed day-to-day spending on defence budgets would end up more than 8pc lower in 2024-25 than at the start of the decade. Education and Home Office spending would also “barely increase” over the three-year spending review period under current circumstances.
The think tank noted that a cut in defence spending would “sit oddly” with both Tory leadership contenders.
Mr Sunak wants to raise defence spending to 2.5pc of GDP “over time”, while Ms Truss has pledged to increase spending to 3pc of GDP by 2030.