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UK tax receipts set to rise £12.5bn more than expected due to inflation

Surging inflation is set to double the effect of planned income tax freezes introduced by UK chancellor Rishi Sunak, raising an extra £12.5bn a year for the exchequer, at a time when budgets are squeezed.

Last March, Sunak announced a four-year freeze from April 2022 of the thresholds at which income tax is paid rather than letting them rise with inflation as normal.

According to analysis by the Institute for Fiscal Studies, published on Wednesday, £20.5bn a year from 2025-26 would be collected in tax rather than £8bn as previously expected due to higher-than-expected inflation.

“It’s a far bigger tax rise than the government was intending at the time,” said Stuart Adam, senior research economist at the IFS. “These are really quite big numbers.”

“No one seems to be talking about the tax rise,” he added, despite it dwarfing the increase in national insurance contributions due to start next month which is expected to raise around £13bn a year.

People in the lowest income brackets, particularly benefit recipients, would feel the impact of rising inflation and freezes to the tax threshold the most, said Adam.

The research highlights the cost-of-living crisis the chancellor will have to navigate at next week’s spring statement.

However, Adam said it was unclear how the government would react to the crisis, warning that the continued strain on public finances made it uncertain if the chancellor would “pocket the revenue”.

“It will be hard for them [the Treasury] to ignore the big squeeze in living standards that’s happening,” he added. “But there are big pressures on the public finances.”

Sarah Coles, senior personal finance analyst at investment platform, Hargreaves Lansdown, said: “We’re facing a horrible stealth tax on our incomes, which will cost us far more than we ever expected. Freezing income tax thresholds in a time of wage inflation is going to have a far bigger impact than anyone initially thought, and hit us just as hard as we initially thought the national insurance hike would.”

The freeze mans that personal allowance — the level at which people start paying income tax on their earnings — will be held at £12,570 until April 2026, rather than rising with inflation. The higher-rate tax threshold will remain at £50,270.

Similarly, the current threshold for inheritance tax and the annual exemption for capital gains tax will remain until 2026. The threshold above which inheritance tax is due, which has not changed since 2009, is currently £325,000. The CGT exemption is £12,300.

The IFS added that the chancellor’s decision showed the “danger” of fixing thresholds over long periods, as unexpected changes in inflation risked unintended consequences.

To calculate the impact of the threshold freeze, the IFS used inflation forecasts from Citi released last week that take account of the inflationary impact of the invasion of Ukraine by Russia.

The think-tank analysed the difference between scenarios under which income tax thresholds rose with inflation each year between 2022 and 2026 and where they remained the same.

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