When Rachel Reeves’s ambition was to find £22 billion, it was already clear that she would need to find more revenue than what was expected to come from the relatively small take hikes the party announced it would pull pre-election. When that number was upgraded to £40 billion, there was no denying that a big tax hike was coming, the kind that tends to come from the major revenue raisers: income tax, National Insurance, or VAT.
Despite being a stealth tax, will it go unnoticed?
Of course Labour ruled out hikes to these three taxes with its tax ‘triple lock’ in the election manifesto. So the party has had to get crafty. For over a week now, the party has refused to rule out hiking employer National Insurance, insisting this isn’t a tax on ‘working people’ (despite broad agreement that it is). Speculation is growing that Labour may well push ahead with this hike, and brace for the political hit when a manifesto rule is perceived to be broken.
But there has long been another option for the Treasury, one which we have been warning about on Coffee House. The Chancellor has, as an option, the opportunity to extend the freeze on tax thresholds, which drags workers into paying higher rates of tax, or paying tax altogether. It’s a painful stealth tax – but an effective one – and it significantly boosts income tax receipts without having to to put a penny (or two) on the basic or higher rate.
Today the Financial Times reports that is likely what the Chancellor plans to do: to extend the current freeze past 2028. Unlike Labour’s plans for VAT on school fees or capital gain tax hikes (which have forecast to bring in significantly less to the Treasury than predicted, or even lose it money), extending the freeze is going to raise major revenue, with the paper reporting the extension could raise up to an additional £7 billion a year.
We know this method works for getting more money into the Treasury’s coffers: mainly because it was the main tax lever the Tories pulled in the last government to get more revenue. The Office for Budget Responsibility most recently estimated that fiscal drag created by the freeze would result in an additional 3.7 million people being pulled into paying income tax by the end of this parliament, with another 2.7 million workers pulled into paying the higher rate. The result: a staggering additional £40 billion raised by 2028-29 – all achieved without having to announce any changes to income tax rates.
Reeves won’t be able to replicate the same headline figure, as inflation did a lot of the heavy lifting post-pandemic (the Tories originally thought the freeze would raise about half that). But it will go some way to finding the Chancellor her £40 billion.
While Labour kept these particular cards close to their chest, it seemed likely that the Treasury would opt for this tax hike. It guarantees more income, and it’s immune from relatively small groups of people – say, working in private equity – from drastically changing their behaviour, which means the tax doesn’t materialise in the long run. It was almost too easy not to opt for this tax hike, which is – ultimately – an increase to millions of people’s income tax bills, but technically not breaching the manifesto promise, as an increase to NI clearly does.
But despite being a stealth tax, will it go unnoticed? While the Tories paved the way for Labour by implementing the freeze, they also showed what happens when significantly hike the overall tax burden: voters rebel. Perhaps the biggest reason the Toires never landed their election line, that they were ‘cutting tax’, was because the money being raised from the threshold freezes were roughly four times the amount of the employee NI cuts that the party had also announced. Yes, the Tories were cutting tax in one area – but they were raising it further in another.
Labour isn’t promising to cut tax, so perhaps the narrative will hold up a bit better. But after so many years of ‘tough decisions’, spending cuts and tax hikes, the government’s decision to take this move out of the Tory playbook won’t be easily explained away. It’s certainly not going to do the party any favours when it tries to paint itself in a different economic light to what came before.
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