The Garrulous Jay – Fiscal Drag Queen

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This week it fell to Jeremy Hunt as Chancellor to give the Autumn Statement one year on from Kwasi Kwarteng’s economic suicide note. Two words you won’t find in the Statement are ‘fiscal’ and ‘drag’. But they were hiding behind the headlines like the words ‘elephant’ and ‘room’.

The Statement painted a picture of economic recovery underpinning tax cuts to turbo-boost future growth. It pointed out that inflation has dropped, the economy has been surprisingly resilient post-Covid and debt is forecast to fall.

This has allowed the Chancellor to deliver “the biggest business tax cut in modern British history”, by making so-called full expensing permanent.

But it gets better… Jeremy Hunt also announced, “the largest ever cut to employee and self-employed National Insurance”, benefiting 27 million workers in the process.

He also confirmed the continuation of the triple lock on the State Pension, boosting it by 8.5%, and a 9.8% increase in the National Living Wage from next April.

What’s not to like? Well, fiscal drag actually!

But before we address the elephant in the room let’s take a look at the context by seeing what the Office for Budget Responsibility (OBR) and the Institute for Fiscal Studies (IFS) had to say about the broader economic outlook.

Following the Autumn Statement the OBR reported:
• We now expect the economy to grow more slowly over the forecast period, leaving the level of real GDP only ½ a per cent higher in the medium term than in our March forecast.
• Past rises in interest rates are still to have their full effect on the economy.
• Living standards…are forecast to be 3½ per cent lower in 2024-25 than their pre-pandemic level.
(Source: OBR – Economic and fiscal outlook – November 2023)

The IFS had a blunter assessment:
• Before assessing the specifics, it’s worth getting a few things straight. The public finances haven’t meaningfully improved. The growth outlook has weakened. Inflation is expected to stay higher for longer.
(Source: IFS – Autumn Statement 2023 response)

So what is this strange elephant in the room? In effect it’s the impact that freezing income tax and NIC thresholds has on people’s overall tax burden as their pay rises to compensate for inflation.

And here’s what the OBR has to say about the impact of fiscal drag:
• Between 2022-23 and 2028-29, this set of threshold freezes means nearly 4 million additional individuals will be expected to pay income tax, 3 million more will have moved to the higher rate, and 400,000 more onto the additional rate.

According to the IFS this in turn means that the changes announced by the Chancellor yesterday…
• give back less than £1 of every £4 that is being taken away from households through changes to NICs and income tax announced since March 2021.

In other words, if fiscal drag was the current in the River Tax and you were in a boat paddling upstream, Jeremy Hunt has just given you a bigger set of oars, which may delay the time it takes you to be swept out to sea.

Careful what you wish for, Rachel Reeves!