The government should react with care to 'cost of living crisis' tax pressures

The cost of living crisis is growing. Inflation is running at 5% and is expected to jump higher in April as the energy price cap lifts. That month will also see the chancellor’s large tax rises, announced last year, come into effect. The two big tax rises that will directly affect workers’ incomes are the 1.25 percentage point increase in National Insurance Contributions (NICs) – announced alongside more money for health and social care in September – and cash freezes to the personal allowance and higher rate threshold in income tax. 

The chancellor has come under pressure – even from some members of the cabinet ^[1] – to delay some tax rises. But this would not help the poorest households much, since many of them do not pay these taxes. Changes to cash benefits would be a better targeted policy for that group, but the government might still want to do something to ease the squeeze for other households. 

Whatever the government decides in the short term, it should not abandon the longer-term case for tax rises needed to meet demands on public spending – or reduce its room for manoeuvre on tax. Those demands will not go away, whatever the government decides in the coming weeks. 

If the NICs rise is delayed now then it might never happen 

Jacob Rees-Mogg and others want to delay the NICs rise. Securing public backing for increasing tax rates is never easy, but the chancellor garnered reasonable support by explicitly linking the tax increase with an announcement on higher health and social care spending.^[2] Delaying the NICs rise now could see growing pressure to continually put off the rise or even to scrap it entirely. This is a particular risk in a parliamentary party already uneasy about the growing size of the overall tax burden – and would leave the government needing to find other ways to fund the increase in health and social care spending to which it has already committed itself.

Two previous episodes of attempted tax rises provide cautionary tales. In the 1990s, the Conservative government announced plans to increase VAT on fuel in two increments – first to 5% and then to the full rate (at that time) of 17.5%.^[3] The first increase happened immediately but the second was continually delayed before eventually being scrapped, a move made easier by the government's failure to legislate for the future increase when it was announced. Rishi Sunak avoided that mistake, but it a decision to delay could be followed be demands to reverse course. The second lesson is Philip Hammond’s attempt in 2017 to increase NICs for the self-employed. The then chancellor argued that more generous pension benefits had been extended to the self-employed the previous year, but the spending and tax announcements were decoupled, leading to a lack of public support and ultimately contributing to a U-turn on the tax rise. ^[4]

Increasing income tax thresholds would make some sense given higher inflation 

In March 2021, the chancellor announced that the income tax personal allowance and higher rate threshold would be frozen for four years from April 2022, rather than being increased in line with inflation, as a way to increase the tax take. The forecast for inflation has since increased, meaning that in October this measure was expected to raise £13bn a year by 2025/26, rather than the £8bn originally anticipated. Arguably, it would be more appropriate to cancel or modify this tax rise than the NICs increase as it is now a bigger tax rise than originally intended. The chancellor could increase the allowance somewhat to make the total size of the tax rise the same as originally intended when the policy was announced. 

It is notable that this measure, which is set to raise almost as much as the NICs rise, is receiving less attention. This fits with findings in our research that increasing tax through inflation has been much easier to achieve historically than changing tax rates, because it tends to be less salient to the public. As a result, a one- or two-year adjustment to the thresholds policy would increase household incomes but would be less likely to undermine medium-term plans to raise taxes than the NICs change. 

Communication of any tax change is crucial 

Previous IfG research on tax policy has shown the importance communicating changes. If the government decides to delay or cancel a tax rise to deal with short-term cost of living problems, it would need to make absolutely clear that this was a one-off measure rather than a rejection of higher taxes per se. The government’s medium-term plans for public spending and lower public debt are predicated on the revenue that will come in from planned tax increases over the next few years. Cancelling those tax rises would mean higher borrowing and weaker public finances than the chancellor has stated he would be comfortable with based on his new fiscal rules.

But the government can make a good case for easing the freeze in income tax thresholds, and it can also make one for postponing the higher rates of NICs. It would need to make clear that the postponement was temporary, emphasising that the NICs rise was only ever a one-year stopgap before the full Health and Social Care levy (that will also apply to pensioners’ earnings) replaces it in April 2023.

If the government does decide to act on tax, it must not allow momentum to build behind the idea that it was rowing back on its previous plans. It would be a very bad outcome if the government’s management of short-term pressures on the cost of living created medium-term problems by restricting tax rises that might be necessary in the long-term. 

1. https://www.dailymail.co.uk/news/article-10377231/Tory-backlash-grows-national-insurance-rise-Rishi-Sunak-faces-pressure-axe-tax-hike.html  
2. https://www.gov.uk/government/publications/build-back-better-our-plan-for-health-and-social-care  
3. www.instituteforgovernment.org.uk/sites/default/files/publications/overcoming-barriers-tax-reform.pdf , p27 
4. www.instituteforgovernment.org.uk/sites/default/files/publications/overcoming-barriers-tax-reform.pdf , p19