We updated our 2012 analysis of fiscal drag on income tax and NICs to reflect new data, our latest assumptions and the effect of measures announced over the past year. This box outlined how fiscal drag effects income tax and NICs receipts and the long-term assumptions used.

HMRC have updated last year’s analysis of fiscal drag on income tax and NICs liabilities between 2018-19 and 2032-33. The analysis is based on the latest Survey of Personal Incomes, updated long-term economic assumptions and the effect of measures announced since last year such as the increases in the personal allowance and the abolition of the NIC contracting-out rebate as a result of the introduction of the Single Tier pension. The results show that by 2032-33 fiscal drag would increase tax revenues by 2.4 per cent of GDP.

These estimates are generated by comparing two different scenarios on HMRC’s Personal Tax Model in which income tax and NICs thresholds and allowances are uprated either with CPI or nominal incomes. As was the case in this analysis last year:

  • around half arises from people moving into paying tax and some taxpayers paying a higher proportion of their income at the basic rate;
  • around a third is from taxpayers moving into the higher rate band, and people paying the higher rate on a larger proportion of their income; and
  • the remaining portion is from the additional rate threshold and the personal allowance taper. The medium-term assumption is that these are fixed in cash terms, so fiscal drag arises from not uprating in line with CPI, and further, not uprating with incomes.

The effect on NICs is much lower. The effect is marginally negative for employee NICs as the marginal rate falls to 2 per cent on earnings above the upper earnings limit (£41,450 in 2013-14). This is offset by the effect on employer NICs where there is no upper limit.

Table A: Income tax and NICs: effect of fiscal drag (2018-19 to 2032-33)

Our long-term assumptions for uprating pensioner benefits are similar to the current medium-term policy settings. In both cases the Basic State Pension is subject to the ‘triple lock’ (rising by the maximum of earnings, prices or 2.5 per cent a year), and the Pension Credit uprated with earnings. For the medium-term forecast, the Second State Pension is uprated by CPI in payment, but average earnings in accruals. The Single Tier pension is legislated to rise at least in line with earnings. For the purposes of these projections, we assume it is also subject to the ‘triple lock’.

Uprating other smaller pension benefits and non-pension benefits to pensioners, including housing and disability benefits, by earnings in the long term means that, in total, pensioner benefits would be 0.3 per cent of GDP higher in 2032-33 than under existing medium-term policy.

Nearly all working-age benefits are due to be uprated by CPI in our medium-term forecast. Our long-term assumption of uprating by earnings, which ensures that living standards for recipients are maintained relative to the rest of the population, therefore has a larger relative effect on prospective spending, equivalent to 1.4 per cent of GDP by 2032-33.

We also assume that student loan fees are uprated with earnings. The medium-term forecast assumes these are uprated with RPIX inflation from 2014-15, but rolling that assumption forward into the long term would imply that university income steadily diminishes relative to the size of the economy.

We also assume student loan fees grow in line with earnings rather than being uprated with RPIX inflation, as in our medium-term forecast. Rolling that assumption forward into the long term would imply that university income would steadily diminish relative to the size of the economy. If fees continued to rise in line with inflation, the impact on net debt from student loans would peak at only 6.1 per cent of GDP and tail off more quickly than in our central projections. In 2062-63 they would add 2.0 per cent of GDP to net debt rather than the central projection of 5.0 per cent of GDP.