Spring Statement 2022 - An initial response from IFS researchers
24 Mar 2022 09:51 AM
IFS Director Paul Johnson responded to the Spring Statement
“There are two paradoxes at the heart of this statement. The Chancellor has managed to announce tax cuts without reducing the planned tax take from previous plans. And by saying nothing about spending, he is reducing the real-terms generosity of his plans for spending on public services. That’s what inflation does.
The cuts to income tax and National Insurance are effectively paid for by increasing revenues as a result of fiscal drag. The freezing of the income tax personal allowance and higher rate threshold turn out to be much bigger tax rises than first intended. As a result, almost all workers will be paying more tax on their earnings in 2025 than they would have been paying without this parliament’s reforms to income tax and NICs, despite the tax cutting measures announced. And by keeping to previously announced cash plans for public spending Mr Sunak is being considerably less generous to public services than he intended when he set out his spending plans in the Autumn.
If he wants to be remembered as a tax reforming chancellor, so far he is headed in the wrong direction. The combination of increased NI rates and a reduced income tax rate will make the tax system both less equitable and less efficient. It will increase the wedge between higher taxes on earnings and lower taxes on pensions and unearned incomes.
But perhaps what really stands out is what was missing. In the face of what the OBR calls the biggest hit to household finances since comparable records began in 1956-57 he has done nothing more for those dependent on benefits, the very poorest, besides a small amount of extra cash for local authorities to dispense at their discretion. Their benefits will rise by just 3.1% for the coming financial year. Their cost of living could well rise by 10%.”
INITIAL REACTION FROM IFS RESEARCHERS
Taxes and incomes
The Chancellor announced cuts to National Insurance contributions (NICs) and income tax. That follows big rises announced to both taxes over the previous year. He has added a cut to the basic rate of income tax (from 2024) and an increase in the NICs threshold (from July 2022) to pre-announced cuts (in real terms) to income tax thresholds and a rise in the rate of NICs. The net effect is to create some who gain overall and some who lose.
For NICs, the threshold at which workers start paying the tax will rise to £12,570 (in line with income tax). That follows a previously announced increase in the main rate of NICs from 12% to 13.25% due to kick in next month. For income tax, we have essentially a mirror image: the Chancellor announced a cut in the basic rate from 20% to 19% in April 2024, occurring alongside the already-announced four year freeze which runs to 2025-26(and therefore sizeable real terms cut) in the thresholds.
What do these reforms mean for tax liabilities and incomes?
- For the coming year as a whole (2022-23), those earning between around £10,000 (the current NICs threshold) and £25,000 will pay less tax on their earnings as a result of these changes. Those earning more than £25,000 will pay more, due to the combined effect of freezing income tax thresholds and increasing the NICs rate.
- By 2025-26 - after the cut to the basic rate of income tax has been implemented and thresholds have continued to be frozen - virtually all workers will be paying more tax on their earnings than they would have paid without these changes to rates and thresholds. This is because freezing thresholds for four years is now set to have such a large impact, given the rise in expected inflation over this period.
- The Office for Budget Responsibility’s forecast is, as expected, for earnings growth to be very weak in the near term, falling by around 2.5% in real terms in 2022-23 - which would be the largest one year drop in real earnings since the late 1970s. This follows around 14 years of very meagre growth in earnings, and means that the average worker is no better off than they were in 2008.
- Bringing together the expected changes in earnings, the reforms to taxes, and the energy measures announced in February, a median (middle) earner on £27,500 per year can expect to be about £360 worse off this year than they were last. A full-time worker on the National Living Wage fares a little better (gaining £140) because of the NLW rising by more than average earnings (though less than inflation) and because of the increase in the NICs threshold. Things are likely to be much tougher for those out-of-work on state support (including pensioners). Inflation is expected to average 8% this year, whereas benefits are due to only go up by 3.1%, implying a (temporary) cut in the real value of benefits of about 5%. The flat rate support for rising energy costs will offset some of that, but in most cases only partially.
Tom Waters, a Senior Research Economist at IFS, said:
“The Chancellor is giving with one hand in tax, having previously taken away with the other. When all is said and done, the reforms imply a greater level of tax for almost all workers - especially those on higher earnings. In the nearer term, many households are likely to see real-terms declines in their incomes with both earnings and benefits failing to keep up with inflation.”
On the public finances
- Strong receipts in the financial year just ending continue into the rest of the forecast horizon. Changes to the economic environment, and in particular much higher inflation, added £33 billion to forecast receipts in the coming year.
- But these higher revenues are entirely eaten up by the increased cost of servicing the quarter of the government’s debt stock that is index-linked. Inflation alone is set to add £32 billion to the debt interest bill, with a further £10 billion coming from higher Bank Rate and the sale of some of the assets held under Quantitative Easing by the Bank of England.
- New measures announced in the Spring Statement - most notably the cut to fuel duties and the increase in the point at which employees’ National Insurance contributions are paid - adds a further £10 billion to borrowing in the coming year.
- Over the medium-term the impact of higher inflation on debt interest is forecast to fall sharply. And the forecasts are predicated on the 5p cut to fuel duty being reversed. This allowed the Chancellor to announce a cut to the basic rate of income tax in April 2024 and still expect the difference between total receipts and day-to-day spending in 2024-25 to be £6 billion bigger than forecast last October.
Public spending
The statement contained no major announcements concerning public spending. Instead, the Chancellor stuck to the cash settlements agreed with departments at last October’s Spending Review, and declined to announce an increase in spending on working-age benefits or pensions. But higher inflation means that those cash settlements are now worth less in real terms – though growth in the GDP deflator (the relevant measure of inflation for the public finances) is forecast to be considerably more muted than in CPI inflation.
- Rather than growing by an average 3.3% per year in real terms over the next three years, as was planned in October, the latest forecasts imply that day-to-day public service spending will grow by 2.9% per year instead. The Chancellor’s spending plans are therefore around 10% less generous than he originally intended them to be.
- The NHS England budget is now set to grow by 3.6% per year, down from 4.1% under October forecasts, and the schools budget by 1.7% per year, down from 2.2%.
- To compensate public services fully - thereby maintaining the real-terms growth rate he announced in October - he’d need to top up his plans for 2024-25 by around £7 billion.
Ben Zaranko, Senior Research Economist at the IFS, said:
“Soaring inflation means a sizeable unintended cut to the generosity of the Chancellor’s spending plans for public services, for the simple reason that the same cash budget can now purchase less in the way of goods and services. Higher inflation has wiped out more than 10% of the real-terms increase he pencilled in last October. Notably, the Ministry of Defence will see the real value of its budget fall between this year and next.
This poses a significant challenge for the Chancellor – though one that he was perhaps wise not to tackle today. It makes more sense to wait for greater clarity on energy prices and pay settlements before making any necessary adjustments in the autumn. If no additional funding is forthcoming, because any fiscal headroom is instead dedicated to pre-election tax cuts, public services will feel the squeeze.”
Fuel duties
Stuart Adam, Senior Economist at the IFS, said:
“A temporary 5p/litre cut in fuel duties is a well targeted way to partly cushion the big rise in petrol and diesel prices we have seen. As long as it is genuinely temporary, the environmental and fiscal costs are bearable. But history suggests it would not be a surprise if the Chancellor failed to restore fuel duties next year to their previously planned level. If the new, lower, level of fuel duties is kept next year – coming on top of more than a decade of freezes – it will leave the duty rate in 2023–24 a third lower than if it had kept pace with CPI inflation since 2010–11, costing the government £13 billion a year.”
See our full coverage of the Spring Statement here >>>