Tax Thresholds Frozen Since the 80s: The Inflationary Squeeze and How They Should Be Adjusted Now

The UK's tax system, a complex web of allowances, brackets, and rates, is currently under intense scrutiny. A key point of contention? The stagnation of tax thresholds, many of which haven’t been meaningfully adjusted to account for inflation since the 1980s. This prolonged freeze has resulted in a significant "fiscal drag," pushing more people into higher tax brackets and effectively increasing the tax burden on millions. This article delves into the impact of this inflationary squeeze, explores potential solutions, and offers a perspective on what these thresholds should be today, factoring in decades of inflation.

The Impact of Frozen Tax Thresholds: A Stealth Tax Increase

The term "fiscal drag" refers to the silent erosion of purchasing power caused by the failure to index tax thresholds to inflation. While nominal income might increase, the real value – accounting for rising prices – often stagnates or even declines. As a result, taxpayers find themselves paying a higher percentage of their income in tax than intended, even without a formal tax rate increase. This is essentially a hidden tax rise, affecting everyone from low-income earners to high-income professionals.

This creeping increase in tax burden is particularly damaging to:

• Lower and middle-income earners: The impact of frozen thresholds is felt most acutely by those with lower incomes, who may find themselves pushed into higher tax brackets as their salaries, though seemingly growing, are merely keeping pace with inflation. This impacts their disposable income significantly.
• Families: Frozen child benefit thresholds and other family-related allowances similarly reduce the financial support families receive, exacerbating the cost of living crisis. High tax rates can make it harder for families to save and plan for the future.
• Pensioners: Pensioners who rely on fixed incomes are especially vulnerable to the impact of inflation. The failure to adjust tax thresholds leaves many pensioners paying a disproportionately high tax burden on their already limited retirement income.

Analyzing the Key Thresholds and Their Current State

Several crucial tax thresholds have remained largely untouched for decades. This includes:

• Income Tax Thresholds: The personal allowance, the amount of income you can earn tax-free, has not kept pace with inflation. This has resulted in a larger portion of the population paying income tax than would have been the case had the threshold been properly indexed.
• National Insurance Thresholds: Similarly, National Insurance contributions, which fund the NHS and other social programs, have seen their thresholds remain relatively static. This has led to more employees paying more in National Insurance than anticipated.
• Capital Gains Tax Allowance: The allowance for capital gains tax, the tax levied on profits from investments, has also been largely frozen, further impacting investors and those looking to sell assets.

What Should the Thresholds Be Now? A Realistic Assessment

Determining what these thresholds should be requires a robust calculation considering decades of inflation. While a precise figure is complex and depends on the chosen inflation index (CPI, RPI, etc.), a reasonable estimate can be made by considering the cumulative inflation since the last significant adjustment to these thresholds. Using a cumulative inflation calculator and considering the last significant adjustments in the early 1980s, a plausible estimation suggests that:

• Personal Allowance: Could potentially be increased from its current level to at least £15,000-£18,000 to reflect true inflation.
• National Insurance Threshold: A similar increase, perhaps to £12,000-£15,000, is justifiable to ease the burden on workers.
• Capital Gains Tax Allowance: This could be significantly increased to a level that reflects the substantial increase in asset prices over the decades.

Addressing the Problem: Potential Solutions

The government has several options to address the issue of frozen tax thresholds. These include:

• Full Indexing: The most straightforward solution is to fully index all relevant tax thresholds to inflation annually. This would ensure that the real value of the thresholds remains constant over time, preventing fiscal drag.
• Targeted Adjustments: Another approach would involve targeted adjustments to specific thresholds, focusing on those most impacting low and middle-income earners and vulnerable groups like pensioners and families.
• Tax Rate Reduction: While less direct, lowering certain tax rates could also mitigate the impact of frozen thresholds.

Conclusion: A Necessary Reform

The prolonged freeze on tax thresholds is not merely a technical issue; it is a significant factor in the UK’s cost-of-living crisis. It disproportionately affects low and middle-income households and undermines the fairness and effectiveness of the tax system. Addressing this issue through proactive and meaningful adjustments to these thresholds is not only economically prudent but also morally imperative. Ignoring this "stealth tax" only exacerbates existing inequalities and risks further economic hardship for millions of Britons. The government must act decisively to reform the tax system and prevent further erosion of taxpayers' purchasing power. The time for decisive action is now.