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Could Income Tax Fall by 2024?
Rishi Sunak is reportedly considering cutting either income tax or National Insurance by two pence before next year’s general election.
The Prime Minister is calculating whether an income tax cut is viable in the current economic climate, considering the persistently high inflation rate. After promising to do so in his leadership campaign, he is said to be keen to follow through.
He believes tax cuts will benefit working people - a policy he strongly supports - according to media reports, although the government has refused to comment officially on the speculation.
Will income tax fall next year?
According to Rishi Sunak, tax cuts were an integral part of the Conservative election strategy to incentivise work and he still believes in this policy. He and his chancellor, Jeremy Hunt, have said although they wish to cut taxes, the immediate priority is cutting inflation by half by the end of 2023.
Mr Hunt had said earlier there was “nothing automatic” about cutting the UK's inflation rate. With core price rises still proving more challenging than expected, there are fears introducing a tax cut in the current economy may have to be put on the back burner until a future date.
Media reports suggest there are no government discussions about tax cuts at the moment, with the focus remaining on reducing inflation. The Treasury, when questioned about cutting income tax, responded, "We don’t comment on speculation about tax changes outside of fiscal events."
Income tax thresholds frozen
Despite the official denial, speculation continues to surround whether a potential tax cut is still on the cards.
Many personal income tax thresholds have been frozen since April 2021 in cash terms. Previously, they were set to rise in line with CPI inflation. Initially, the rate was frozen up to and including the financial year 2025/26.
In the autumn budget statement in 2022, Hunt extended the freeze until 2027/28. The six-year freeze in the personal allowance takes it back to 2013/14 levels in real terms. All the main personal tax thresholds are now frozen.
The freeze will result in "fiscal drag" - which will raise a significant sum for the Treasury in the longer term. Fiscal drag occurs when more people are "dragged" into paying taxes at a higher rate. It results from tax thresholds and allowances failing to keep up with inflation or wage growth.
The average effective tax rate increases faster over time, based on the total tax paid as a share of total income. As earnings increase relative to tax thresholds, more of the taxpayers’ income will be taxed - and a greater amount of what is taxed will fall into a higher tax band.
The Office for Budget Responsibility has said fiscal drag is "not uncommon" and estimates the current freeze of the higher rate threshold and personal allowance will raise more than £25 billion a year for the Treasury in 2027/28.
Critics have labelled this method of raising money a "stealth tax". However, supporters of fiscal drag say the tax freeze in the current high-inflation environment will help raise revenue to cover the costs of Covid-19 schemes introduced in 2020 during the pandemic.
Despite the benefits of extra revenue for the Treasury, even the scheme's supporters recognise that the reduction in the real value of people’s income "will be felt".
How does the tax policy affect SMEs?
For SMEs in particular, the government's current tax policies, especially fiscal drag, will stifle growth. An expert panel of economists, the Tax Policy Associates, had slated the Autumn Statement as "lacking vision", claiming it contained "no confidence boosters" and "didn’t incentivise small business growth".
The panel believes it creates the potential for a "major fiscal crisis" a few years down the line. Experts have suggested the Chancellor should implement changes to inheritance tax, capital gains tax, stamp duty and council tax to help balance the books.
New data has revealed 75% of the UK's small businesses have used external accounting services in recent years to help make the most of their finances.
Of those who have used a professional accountant, 72% admit they have done so simply because it "makes them feel better" knowing someone with the relevant in-depth knowledge is helping them through the crisis.
However, 22% of SMEs are not taking advantage of professional help in managing their payroll. Research reveals companies with between ten and 250 employees tend to manage it themselves.
With the current uncertainty about income tax and National Insurance, financial experts say businesses working from "time-consuming and error-prone manual spreadsheets" could be creating more problems for themselves, rather than saving money.
Warning against tax cuts
News of the potential Rishi Sunak income tax cuts has led the International Monetary Fund to issue a warning against this course of action. The IMF says any cuts will increase the risks of fuelling inflation further. It could also spark lasting high interest rates.
The body urged the Treasury to stick to its plans to reduce public spending, using any surplus income to pay off debt and rebuild the nation's fiscal buffers.
Experts at the IMF also warn that any new tax cuts announced before the next general election may not prove permanent.