Tax and NI: Middle classes must stump up to cut the deficit

Triple whammy targets families earning above the national average

Middle Britain got a sense of the tax pain to come after the next election in the Chancellor's pre-Budget report yesterday. Income tax personal allowances were frozen, national insurance contributions increased again and those hoping to leave property to their loved ones were dealt a blow as the amount they could give free of inheritance tax (IHT) was frozen.

"Personal allowances, National Insurance and IHT: it's bad news for the middle classes," said Chas Roy Chowdhury, head of tax at the Association of Certified Chartered Accountants.

"A lot of the attention in the run-up to the pre-Budget report focused on bankers' bonuses but it seems the Chancellor has chosen now to start turning the screw on families that earn a little more than average," he added.

The increase in national insurance contributions by 0.5 per cent from April 2011 (on top of the 0.5 per cent rise announced in the last budget) has been criticised as a covert tax rise.

"The Government have form here. Instead of raising the income tax rate what they have tended to do is increase NICs or freeze personal allowances. This time they've done both," said Erike Jupe, a tax partner at London accountancy firm Osborne Clark.

Tim Walford-Fitzgerald, from accountancy firm HW Fisher, says the 0.5 per cent rise in NICs comes at a bad time for the economy: "The rise coincides with when many expect the employment situation to start turning around. It will apply to employers as well as employees, making it costlier for businesses to recruit and retain staff. In effect this is a tax on jobs."

But with the government deficit predicted to be as high as £175bn next year the Treasury could badly do with the £3bn that the NICs increase raises.

Those on lower incomes will be cheered by the Chancellor's promise to raise the starting point for NICs so that no one earning under £20,000 a year will lose out. However, they will suffer from the decision to freeze income tax personal allowances during the 2010-2011 tax year.

For those on middle to high incomes the news on personal allowances was worse still: those paying 40 per cent tax will have their allowance held for a year from April 2012.

"This is really damaging for many ordinary families. Teachers, middle managers and many working in the health service will be affected by this double whammy," Mr Chowdhury said.

The decision will re-ignite the debate of fiscal drag – where more and more people are pulled into the 40 per cent tax bracket because allowances do not keep pace with wage rises.

"If you're earning £40,000 or just under now," Mr Walford-Fitzgerald said, "there is every chance that once this freeze on allowances is over you will be paying 40 per cent tax. Allowances have not been keeping pace with wages and have been tracking inflation instead. Now they will stop dead. The unfair thing is that many of the top earners and business owners can manipulate their incomes so that they pay as little tax as possible while those on middle incomes with relatively ordinary jobs don't have this option, so they will end up bearing the brunt."

An extra 70,000 people are now expected to be paying 40 per cent income tax by 2013, bringing an extra £400m into the Treasury.

Inheritance tax is likely to be a battleground in the general election. The Tories have promised to raise the size of an estate that can be left free of IHT to £1m but the Chancellor chose to reverse a previous commitment to raise the IHT threshold to £350,000 next April, instead leaving it at £325,000 – a decision that has left a clear divide between Labour and the Tories.

Lower down the income scale, talk of IHT thresholds may seem a moot point. And in what the Chancellor dubbed a pre-Budget all about "fairness" they received some good news, including rises in child benefit, free school meals for an extra 500,000 children and continuation of the Homeowner Mortgage Support Scheme for an extra six months.

The view from the marginals: 'Darling made tough choices'

Michael Wager, a 25-year-old customer services consultant, earned about £16,000 last year.

"The lower VAT rate has never really affected me because I was trying to keep my spending low to save money. Unfortunately, the relatively low interest rate means it has taken me longer to save the money I need. I've also found the costs of running a car increasingly prohibitive, which is frustrating because a car is becoming a necessity.

"I'd like to see a more obvious correlation between the rising tax receipts and an improvement in public transport. There were some potentially unpopular things in the report, for example, the rise in VAT and National Insurance rates. They are probably necessary in the longer term but in the short term they are vote-losers.

"That said, I would be more tempted to vote Labour in the next election because I think they are making tough choices and not simply chasing votes.

"Of course, if interest rates stay low – and I expect them to do so in order to stimulate economic growth – then, as a saver, I am less keen."

Constituency: Gloucester; Labour Majority in 2005: 4,271

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