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UK Slashes National Insurance Tax Amid Fiscal Drag

2023.11.24

 

Key Takeaways

  • National Insurance tax cut from 12% to 10%, offering some relief to workers.
  • Frozen tax thresholds continue to contribute to a rising tax burden despite the cut.

Major Tax Cut Announced

In a move to alleviate the financial strain on workers amidst a cost-of-living crisis, UK Finance Minister Jeremy Hunt announced a substantial reduction in National Insurance (NI) tax. The rate will drop from 12% to 10%, potentially saving an average worker over £450 annually. This decision, costing the government about £10 billion, is part of Prime Minister Rishi Sunak’s Conservative government’s efforts to offer respite to voters facing economic hardships.

The Shadow of Fiscal Drag

Despite this “largest ever tax cut for workers,” as touted by the Conservative party, the benefit is significantly diminished by the existing freezes on personal tax thresholds, a phenomenon known as “fiscal drag.” With thresholds frozen, more income falls into higher tax brackets as nominal wages rise, leading to increased tax collection by the Treasury. The Office for Budget Responsibility (OBR) notes that these freezes are expected to raise £44.6 billion by 2028-29, overshadowing the NI cut’s impact.

Tax Threshold Freezes Extended

Former Finance Minister Rishi Sunak initially froze the personal allowance (PA) and higher-rate thresholds (HRT) of income tax until April 2026, which Jeremy Hunt extended to 2028. The continuation of these freezes means that as wages increase nominally, more individuals will fall into higher tax brackets or become taxpayers. This shift is expected to add nearly 4 million additional income tax payers and significantly raise the Treasury’s revenue.

Economic and Political Implications

The OBR has highlighted that these threshold freezes are the primary contributors to the rising overall economy-wide tax burden. The move to cut NI, while offering some immediate relief, does not counterbalance the long-term tax increases and public service budget constraints. Experts like Torsten Bell of the Resolution Foundation and Paul Johnson of the Institute for Fiscal Studies have emphasized that most of the country will be worse off, with the cut unable to offset the biggest tax-raising parliament in modern times.

Younger Workers Bear the Brunt

The decision to cut NI and allow fiscal drag to continue raises concerns about the burden on younger workers. As the population ages and retirement periods extend, the responsibility for funding future spending commitments will increasingly fall on the younger demographic. This scenario is exacerbated by policies like the triple lock on state pensions, which contrast starkly with the higher taxes and inflation impacting young people’s incomes.

 

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