The Treasury will impose an additional £21bn of income taxes despite Liz Truss's "tax-cutting" mini-Budget, a detailed analysis released on Thursday has revealed.
The average household will be £1,450 per year worse off as a result of the stealth raid, according to the Institute for Fiscal Studies (IFS) think tank.
The typical basic rate taxpayer will pay an added £500 in income tax and National Insurance per year by 2026 while higher rate earners are facing a £3,000 annual increase.
The figures are based on analysis of the decision by Kwasi Kwarteng to freeze tax thresholds, which in three years' time will deliver an extra £41bn to the Exchequer amid high inflation and rising wages. Meanwhile, his cuts to personal taxes will be worth only £20bn.
The so-called fiscal drag effect is likely to form a key part of a report by the Office for Budget Responsibility due to be delivered to the Chancellor on Friday. It is expected to pave the way for him to be able to say that debt will fall as a share of GDP after markets took fright at his “unfunded” tax cuts.
The four-year freeze to multiple tax thresholds was announced by Rishi Sunak when he was Chancellor as he sought to stabilise the public finances following the pandemic borrowing binge.
It was announced before the surge in inflation and wages boosted the amount the Exchequer would generate from the policy.
Mr Kwarteng has promised to push ahead with more tax cuts next year, leaving him scope to reverse the huge amounts of revenue generated by fiscal drag under the policy set out by Mr Sunak.
Fitch on Wednesday became the third rating agency to signal the Prime Minister’s tax cuts had put the UK’s credit rating at risk of a downgrade.
Changing its outlook to “negative”, it said the plan had damaged the country’s “long standing” credibility with investors and put its debt trajectory on a path that was no longer consistent with its AA- rating.
Confirmation of the stealth tax rise will deal a blow to Ms Truss’s claim she will slash the burden of the state to unleash growth, as the IFS urged her to “kick the habit” of freezing tax thresholds.
The Prime Minister on Wednesday used her first Tory conference speech as leader to recommit to a push for economic growth after a week overshadowed by Tory in-fighting.
She echoed Margaret Thatcher by naming “enemies of enterprise” and warning “we have no alternative”, similar to two phrases used by the Iron Lady.
Ms Truss said: “I will not allow the anti-growth coalition to hold us back. Labour, the Lib Dems and the SNP. The militant unions, the vested interests dressed up as think-tanks.
“The talking heads, the Brexit deniers and Extinction Rebellion and some of the people we had in the hall earlier. The fact is they prefer protesting to doing.
“They prefer talking on Twitter to taking tough decisions. They taxi from North London townhouses to the BBC studio to dismiss anyone challenging the status quo.”
The short speech, a little over 30 minutes, made clear she was sticking to her mini-Budget package and laid out the pitch for why the drive was needed. Ms Truss promised to create a “country where hard work is rewarded” but more adults than ever will pay the higher (40pc for £50,271 to £150,000) and additional (45pc for over £150,000) rates of income tax.
The IFS said the share of adults paying income tax will jump from 63pc now to 66pc within three years, matching the record levels reached during New Labour. An all-time high of 14pc will pay the higher rate of income tax, an extra 1.6m people.
Tom Waters, economist at the IFS, urged the Government to “kick the habit” of freezing tax thresholds, warning it “smacks of lazy policymaking”.
“Worryingly, it seems like there is a growing trend towards introducing new parameters to the system that are indefinitely frozen,” he said.
“From the Treasury’s perspective, one can see that undoing such freezes might not be appealing, given the state of the public finances. But that doesn’t change the fact that there are far less opaque and arbitrary ways to raise revenue.”
Meanwhile Liz Truss was warned by Cabinet that her plan to cut benefits “will never happen” after Jacob Rees-Mogg became the latest top minister to revolt.
The Business Secretary joined fellow members of the Prime Minister’s top team in voicing disquiet at her and the Chancellor’s bid to rein in welfare spending.
It is understood he argued that increasing handouts to reflect rising prices was the only political reality amid a cost-of-living crisis.
Downing Street is exploring whether to increase Universal Credit by the same amount as average wage growth rather than by inflation as is usual.
Such a move would see welfare payments rise by around 6pc meaning claimants would see a real-terms cut of 4pc to their budgets.
The Resolution Foundation think tank has calculated that hiking benefits only in line with average wage rises would save £9 billion over the next two years.
But there is a growing Cabinet revolt over the idea, with some members of the Prime Minister’s top team publicly breaking ranks.
The Telegraph understands that one Cabinet minister has privately told Ms Truss the cut “will never happen” given the widespread opposition within the Tory party.
Penny Mordaunt, the Leader of the Commons, said on Tuesday that she had “always supported” inflation matching rises.
“It makes sense to do so, that’s what I voted for before. We want to make sure that people are looked after, and that people can pay their bills.
“We are not about trying to help people with one hand and take away with the other,” she told Times Radio.
Ms Truss and Mr Kwarteng have promised to revive Britain’s anaemic growth rates with a slew of tax cuts for households and businesses, including the reversal of the NI increase and a reduction in the basic rate of income tax to 19pc.
However, fiscal drag pushes more taxpayers into higher bands as prices and wages continue to rise, generating billions of pounds in extra revenue for the Government.
The Treasury will make much more revenue than first thought because of the quicker inflation and earnings growth seen in the UK.
As a result of the freeze to the personal allowance – currently £12,570 – the number of income tax payers will rise to 35.4 million by 2025-26, the IFS said, dragging an extra 1.4 million workers into the net.
In addition, 7.7 million people – 14pc of adults – will be paying the higher rate of tax, the largest proportion on record and 1.6 million more than now. The number of additional rate taxpayers will soar to 760,000, three times higher than when it was introduced on incomes over £150,000 in 2010.
The report also found that half a million more families will lose some or all of their child benefit over the next three years because the £50,000 threshold at which it is tapered away has been frozen since 2013. This means the total number of families affected will rise to 2.5 million – where initially it was only 1 million.
An HM Treasury spokesperson said: “This Government is committed to a high growth and low tax economy and helping people to keep more of their hard-earned money is a key priority, as seen by our commitments to cancel the rise in National Insurance and reduce the basic rate of income tax.
“The income tax system is highly progressive. This year, the top 50pc of income taxpayers are expected to pay around 92pc of total income tax, while the bottom 25pc are expected to pay just 2pc.”
On Thursday the Prime Minister will travel to Prague for a meeting of the European Political Community, the brainchild of French President Emmanuel Macron.
Ms Truss will urge Mr Macron to work with the UK on curbing the flow of small boats carrying asylum seekers across the English Channel, and energy independence.