A lack of inflationary increases means we'll all be paying more tax.
Now I know it's pantomime season, but don't worry, this article does not concern itself with the extra-curricular activities of the Chancellor -- the idea of Alistair Darling in fishnets, false eyelashes and frills is not most people's idea of a Christmas Cracker!
The concept of fiscal drag relates to the adverse interaction of tax and inflation, and specifically where, even though no specific action is taken by the taxing authority or the individual, the individual ends up paying more tax or his net income ends up buying less.
The current economic downturn, leading to negative inflation rates, has brought the concept into sharper focus, confirmed and exacerbated by some of the Pre-Budget report announcements earlier this month.
The impact of inflation
In the tax world, the retail prices index (RPI) figure for the end of September is used when determining inflationary increases for the following tax year; thus for 2010/11 the relevant figure is September 2009.
Given that things haven't been going all that well recently -- even Mr Darling conceded that "the first half of this year saw a sharper deterioration than had been expected… here in the UK" -- the RPI figure for September 2009 was actually negative at -1.4%.
Now whilst the Government is not actually bah humbug enough to start taking allowances and index-linked benefits away from the tax paying public, it does mean that these things will not be increased for 2010/11. So what exactly are we talking about?
Tax Allowances and Tax Rate Bands
The current personal allowance of £6,475 will be frozen at that level. The Chancellor does have the power to increase allowances to whatever level he chooses, but in the absence of any contrary provisions, an inflationary increase is automatic.
This means that, for 2010/11, when inflation is expected to increase prices by between 1 and 1.5 per cent according to the Chancellor's own estimations, taxpayers will have the same amount of net income but will be paying more for things, making us feel poorer. Thanks Darling.
Worse, from 6 April 2012, the point at which taxpayers start paying 40% income tax will be frozen for a further year, instead of rising with inflation. Although this hasn't really been highlighted in Pre Budget Report comment, this single measure is expected to raise £400 million in tax revenues alone.
State Pension and SERPS
Along with certain other index-linked benefits such as Child Benefit, the State Pension and SERPS are also dependent on inflationary increase.
However, the Chancellor felt this would be unfair to the nation's pensioners so announced a 2.5% increase in the basic state pension from April 2010. Some would argue that the 2% reduction in Bingo duty would have gone some way to compensating pensioners, but I digress.
However, as ever in recent years, the devil is in the detail, and careful perusal of the facts reveals that the SERPS pension amount, normally paid with the state pension, has not been included in the 'fair' 2.5% increase.
In simple terms then, basic pensioners will be protected from fiscal drag but those individuals who dutifully paid NI contributions into the SERPS scheme over 30 or 40 years will not. Very equitable.
And finally, the non-means tested Child Benefit will also increase by 1.5%.
So has the Chancellor been fair in the way fiscal drag is suffered? (Oh no it isn't. Oh yes it is!) Or will it all be academic if, as expected, we have a new Chancellor in 2010 who will change all the rules anyway?
Perhaps Mr Darling should be looking over his shoulder, after all, "it's behind you…"
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