Frozen tax thresholds and their impact on economic growth in the UK

Exploring the implications of tax bracket creep on middle-income earners

Frozen tax thresholds and their impact on economic growth in the UK

The economic landscape in the UK is facing significant challenges, particularly for middle-income earners. A recent warning from Catherine Mann, a member of the Bank of England’s Monetary Policy Committee, has highlighted the detrimental effects of frozen personal tax thresholds on economic growth.

As inflation continues to rise, many individuals find themselves pushed into higher tax brackets, a phenomenon known as ‘tax-bracket creep.’

Understanding tax-bracket creep

Tax-bracket creep occurs when inflation pushes taxpayers into higher income tax brackets, even though their real purchasing power remains unchanged.

This situation is particularly concerning for middle-income earners, who are disproportionately affected. Mann emphasized that this group has been exposed to a greater degree of tax-bracket creep, which ultimately erodes their purchasing power. As a result, many individuals are now paying higher rates of tax without any actual increase in their income.

The implications for economic growth

According to Mann, the Bank of England has concluded that frozen tax thresholds are a “significant drag” on economic growth. While the government has pledged not to increase income tax rates, plans to extend the freeze on income tax thresholds could raise an additional £7 billion annually. This move would exacerbate the fiscal drag effect, where individuals with the same nominal income find themselves paying more in taxes due to inflation.

As inflation rates fluctuate, the purchasing power of consumers diminishes, leading to reduced spending and investment. This cycle can stifle economic growth, as businesses may face declining demand for their products and services. The Bank of England’s recent findings suggest that the UK economy still faces “a lot more inflation,” which could further complicate the situation.

Government response and future outlook

In light of these challenges, the government is under pressure to reassess its fiscal policies. The Chancellor, Rachel Reeves, is reportedly planning to introduce new debt rules that would allow for increased borrowing to fund infrastructure projects. While this could stimulate economic growth in the long term, it raises concerns about the sustainability of public finances.

As the government navigates these complex issues, it is crucial for policymakers to consider the long-term implications of frozen tax thresholds and the impact on middle-income earners. Addressing these concerns may require a comprehensive review of the tax system to ensure that it supports economic growth while protecting the purchasing power of consumers.