We have heard very little recently of the Chancellor’s friend but fiscal drag has been beavering away largely unnoticed, raising or saving money for him. Fiscal drag raises extra money when tax allowances do not rise with inflation. That brings more people into the scope of paying that tax and more money for the Chancellor. At the other end, fiscal drag saves money on benefits when they rise by less than the rate of inflation, cutting the amount paid to those in and out of work.
Fiscal drag has been hidden partly by the policy of the coalition government to raise the personal tax allowance well ahead of inflation – costing the Treasury billions. Part of that cost was paid by the better off when the threshold for higher rate tax was correspondingly cut. But that policy has now been reversed and the income at which higher rate tax begins will be raised from April.
In England, Wales and Northern Ireland it will go up by £2,000 to £45,000 a year and then to £50,000 by 2020. Scotland has asserted its recently granted tax independence to choose a lower threshold, raising it by only 1 per cent to £43,430.
However, Scotland has no devolved powers over National Insurance, so the threshold where NI rates fall from 12 per cent to 2 per cent – which is linked to the higher rate threshold – will rise throughout the UK to £45,000. That means some Scottish residents will face a marginal tax rate of 52 per cent (40 per cent income tax + 12 per cent NI) on income from £43,430 to £45,000.
But there are three income tax thresholds above that which have not been adjusted since they began. And they are champion fiscal draggers.
At £50,000, people with children begin to lose their child benefit. It disappears as the income of either partner reaches £60,000. This High Income Child Benefit Charge began in January 2013 and the thresholds for it have never changed, even though average pay has risen more than 8 per cent.
In the zone from £50,000 to £60,000, marginal tax rates are more than 60 per cent for those with two children, 75 per cent with four and reach more than 100 per cent for those with eight. In other words, they earn an extra pound and end up worse off.
High earner personal allowance
Jump next to £100,000. Since April 2010 that has been the point where the personal tax allowance begins to be phased out at the rate of £1 for every £2 income above that level. Currently, the £11,000 personal allowance disappears as income tops £122,000. The marginal rate of tax in that band is 60 per cent. From April, the band will be £1,000 wider at £123,000 before the new £11,500 personal allowance disappears. Since 2010 pay has risen by 13 per cent.
At £150,000 the top rate of tax kicks in at 45 per cent. That rate was cut in 2013/14 from the 50 per cent it started at in 2010/11. But the threshold at which it begins has never changed. Initially it caught just 0.7 per cent of taxpayers. Now it is 1.1 per cent and will rise to an estimated 1.5 per cent by 2021 when 469,000 people will pay it.
Inheriting tax and the nil rate band
Inheritance tax thresholds have also been frozen. The £325,000 nil rate band above which IHT begins has not been raised since 2009, dragging thousands more estates each year into its web (though the proportion of estates paying it is still well below 10 per cent). In that time, house prices have risen by 38 per cent.
From April an additional nil rate band will apply to the deceased’s main residence as long as it is left to a direct descendant. It will be £100,000 in April 2017 and rise to £175,000 by April 2020. That will mean some widow(er)s (who get double nil rate bands) will be able to leave up to £1m free of IHT to their descendants.
Also frozen for many years are the limits on annual gifts. The total of £3,000 a year and the small gifts limit of £250 to any number of other individuals have not changed since 1995. They should now be £5,250 and £450. The limits of £1,000 to £5,000 for a gift made at a wedding are unchanged since 1979. They should be quintupled.
Putting money back in the Chancellor’s pocket
Fiscal drag does not just affect the rich. In April, millions of working people whose low pay is topped up by benefits and millions more who are looking for work or unable to work will have no rise at all in their money.
Benefits for working age people who are not disabled are frozen until 2020. By April, it is expected to be around 2 per cent and rising. So that will be a real terms cut in benefits paid to the poorest even before other austerity programme cuts kick in for new claimants. Freezing benefits – a formal version of fiscal drag – is expected to save £4bn a year by 2019/20.
Even before the freeze, fiscal drag was found buried away in the benefit rules. The Bereavement Payment for a widow(er) of someone who dies under pension age has remained at £2,000 since it was introduced in 2001 (though it is due to change radically this year).
The capital limits which apply to those claiming means-tested benefits have remained the same since 2006 when they saw their first rise since 1990. The amount of earnings ignored when means-tested benefits are worked out has also been fixed for many years. Fiscal drag remains the Chancellor’s friend, silently bringing in more money or paying out less as inflation does his work for him. There will be two Budgets this year but we are unlikely to hear its hard work acknowledged in either.
Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programme. You can follow him on Twitter @paullewismoney