The National Insurance tax on workers will be significantly reduced, as stated by U.K. Finance Minister Jeremy Hunt on Wednesday. However, the impact of current caps on personal tax levels, sometimes referred to as the "fiscal drag," will outweigh the tax payers' advantage.

To fund state social security benefits, such as the state pension, the United Kingdom imposes a levy on employers' earnings and worker income known as the National Insurance.

(Photo : by ISABEL INFANTES/AFP via Getty Images)
The National Insurance tax on workers will be significantly reduced, as stated by U.K. Finance Minister Jeremy Hunt on Wednesday.

Ahead of a general election, Prime Minister Rishi Sunak's Conservative administration was eager to provide a stick to voters who had been severely impacted by the cost-of-living problem in recent years, since they were well behind the major opposition Labour Party in the polls.

Hunt consequently said that workers' national insurance will be reduced from 12% to 10%, which would benefit 27 million people and save an individual earning the national average wage of £35,000 ($43,774.50) annually more than £450. The government will have to pay almost £10 billion for this decrease.

Although the Conservative party has hailed the decision as the "largest ever tax cut for workers," people are still vulnerable to the impact of static tax thresholds, which shift more of their income into higher tax rates when nominal earnings grow.

Office for Budget Responsibility's Assessment of National Insurance Reductions

The independent Office for Budget Responsibility emphasized that the reduction to NI is little in comparison to the enormous sums of money the Treasury will be collecting over the next few years due to the ongoing effects of many freezes and reductions to personal tax levels in recent years.

The personal allowance (PA) and higher-rate thresholds (HRT) of income tax will be frozen for four years, ending in April 2026, according to an announcement made in March 2021 by then-finance minister Rishi Sunak. Hunt's 2022 Autumn Statement then increased the freeze's duration until 2028.

Read also: UK Payments Report Challenges Mastercard and Visa Dominance, Seeking Alternatives for a Fairer Market

Changes in Tax Bands and the NI Reduction's Limited Impact

In 2021, Sunak fixed the PA at £12,750 and the HRT at £50,270. In addition to prolonging the freezes, Hunt reduced the extra rate hold from £150,000 to £125,140 effective April 2023 and froze the top earnings cap for NI contributions in November 2022.

Millions more people are pushed into higher tax bands or into the tax system after previously falling below the needed income level as a result of the tax thresholds being frozen rather than rising in step with inflation.

By the end of the projected period in 2029, these freezes are now estimated to earn the Treasury £44.6 billion, or 1.4% of GDP, compared to rising thresholds in line with inflation. Hunt's reduction to NI will "reduce the impact of the primary threshold freeze by only around £180 million."

Chief executive of the Resolution Foundation Torsten Bell noted on Wednesday that only individuals making between £11,000 and £13,000 annually and between £42,000 and £52,000 annually will gain from the 2p cut to NI, leaving the great majority of the population worse off.

Related article: Your Spending Data May Reveal Aspects Of Your Personality