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Millions could be worse off with wage inflation

The Government has a vision for a high-wage economy, but wage inflation could lead to millions being less well-off writes David Hough.

Wages are increasing as a result of inflation, reflecting that the cost of goods and services is going up. However, higher salaries do not mean individuals will have the income to cover the cost of rising prices.

People could find that increasing earnings moves them into a higher rate of tax, or they lose other income support, meaning that their net pay does not increase proportionately to the greater cost of living.

The Chancellor will foresee two main benefits to increasing inflation:

  1. Where adjustments to tax brackets for lower and higher earners, and benefit thresholds, do not keep pace with wage inflation, the impact will be greater tax receipts and lower benefit payments for the Government, as individuals are pushed into higher tax brackets or suffer a reduction in entitlement to benefits. The Chancellor announced in the Spring Budget that the personal tax allowance and higher rate threshold would be frozen from April 2022 to April 2026.  Over one million people were estimated to become taxpayers due to the freeze to the personal tax allowance and wage inflation will increase this further. In principle it sounds fantastic that wages are going up and the perception that reliance on the state is coming down, but inflation will drive up the cost of living and individuals will find that they are worse off unless thresholds for paying taxes, or receiving income support are adjusted; accordingly.
  2. It lowers the value of Government debt, as inflation rates increase the numeric value of the pound sterling relative to the cost of borrowing. Net borrowing was 14.5% of GDP in the year to 31 March 2021, according to ONS, with the ramifications of Covid-19 support measures still accumulating.

Inflation rates have been creeping upwards during the summer, 3.2% per the August ONS announcement and the Government now appears tempted to allow inflation to run above its monetary policy of 2%. Challenges with supply lines have led to increases in costs of raw materials and transportation, but we are now seeing the Government champion the impact of rising wages. However, care must be taken to ensure inflation rates do not become hard to control.

As the health and social levy has been applied to employers as well as employees, it represents a cost of doing business which will drive up prices. At the same time, the Government has been clear that it wants to reduce the reliance on low pay through immigration and for employers to pay more to recruit locally. These policy decisions will mean that business owners will have to increase the cost to the consumer to remain profitable.

For small business owners the challenges are particularly acute, as increases to Corporation Tax and dividend rates mean they have little choice but to charge more to their customers.

The problem with inflation is that once prices start to increase more rapidly it can become hard to control them, especially where demand is exceeding supply and the ramifications of Brexit and Covid-19 mean that is the case in areas such as transportation.

The Bank of England could increase interest rates if it were worried that inflation was getting out of hand. However, doing so puts significant pressure on homeowners and businesses, many of which are suffering the from the impact of Covid-19 and the financial burden of higher interest rates could be too much to handle.

Critically, the Chancellor needs to protect the net income of individuals by ensuring that they are not significantly worse off from inflation on the one side, and tax rises on the other. The rebound of the economy and success of small businesses requires individuals to have the confidence to spend.

Would you like to know more?

If you would like to discuss the above or how it may affect you and your business, please get in touch with your usual Blick Rothenberg contact or David Hough, using the details on this page.

For press enquiries, please contact David Barzilay using the details on this page.