LONDON — U.K. Finance Minister Jeremy Hunt on Wednesday announced a substantial cut to the National Insurance tax on workers, but its benefit to payers will be dwarfed by the effect of existing freezes on personal tax thresholds — known as the “fiscal drag.”

The U.K. National Insurance is a tax on workers’ income and employers’ profits to pay for state social security benefits, including the state pension.

Trailing the main opposition Labour Party substantially in the polls ahead of a general election, Prime Minister Rishi Sunak’s Conservative government was keen to offer a carrot to voters who have been pummeled by a cost-of-living crisis over the last couple of years.

Hunt therefore announced that National Insurance for workers would be cut from 12% to 10%, benefiting 27 million people and saving someone on the national average yearly salary of £35,000 ($43,774.50) over £450. The reduction will cost the government around £10 billion.

Touted by the Conservative party as the “largest ever tax cut for workers,” the move nevertheless does not shield taxpayers from the effect of frozen tax thresholds that tip more of their income into higher tax brackets, as nominal wages rise.

The independent Office for Budget Responsibility highlighted that the continuing impact of multiple freezes and reductions to personal tax thresholds in recent years means that the cut to NI is a drop in the ocean, compared to what the Treasury will be raking in over the next few years.

“High levels of inflation and the impact of fiscal drag means they are now expected to raise a combined £44.6 billion in 2028-29,” the OBR said in its medium-term outlook published Wednesday.

In March 2021, then-Finance Minister Rishi Sunak announced that the personal allowance (PA) and higher-rate thresholds (HRT) of income tax would be frozen for four years until April 2026. Hunt then extended that freeze to 2028 in his 2022 Autumn Statement.

The PA was frozen by Sunak in 2021 at £12,750, with the HRT set at £50,270. Alongside extending the freezes, Hunt in November 2022 froze the upper earnings limit for NI contributions and lowered the additional rate hold from £150,000 to £125,140 from April 2023.

Freezing the tax thresholds, rather than increasing them in line with inflation, means that, as nominal wages rise, millions more people are tipped into higher tax brackets, or into the tax system having previously been below the required income level.

“Between 2022-23 and 2028-29, this set of threshold freezes means nearly 4 million additional individuals will be expected to pay income tax, 3 million more will have moved to the higher rate, and 400,000 more onto the additional rate,” the OBR said.

Relative to raising thresholds in accordance with inflation, these freezes are now expected to raise the Treasury £44.6 billion by the end of the forecast period in 2029, or 1.4% of GDP, while Hunt’s cut to NI will “reduce the impact of the primary threshold freeze by only around £180 million.

“Frozen thresholds are the largest contributor to the rising overall economy-wide tax burden – responsible for almost a third the 4.5 per cent of GDP increase in taxes from 2019-20 to 2028-29,” the OBR added.

Torsten Bell, chief executive of the Resolution Foundation, pointed out on Wednesday that despite the 2p cut to NI, the vast majority of the country will be worse off, with only those earning around £11,000 to £13,000 per year and around £42,000 to £52,000 a year benefiting.

Younger workers to foot the bill

Paul Johnson, director of the Institute for Fiscal Studies, said that despite Hunt’s optimism, the U.K.’s public finances “haven’t meaningfully improved,” with the growth outlook still weak and inflation expected to stay higher for longer.

“Higher inflation pushes up tax receipts by more than it pushes up spending on debt interest or social security benefits; but rather than use the proceeds to ease the ongoing ‘fiscal drag’ effects of threshold freezes, or to compensate public services for higher costs, the Chancellor opted to cut other taxes,” he said.

“His immediate cut to National Insurance will put more money into workers’ pockets when it comes in but won’t be enough to prevent this from being the biggest tax-raising parliament in modern times.”

Though he acknowledged that cutting NI is preferable to cutting personal income tax rates and may help to boost employment, Johnson noted that these tax cuts have been “paid for” by letting the fiscal drag manifest as an even larger medium-term tax increase and a bigger squeeze on both public service budgets and investment.

Michael Ben-Gad, professor of economics at City, University of London, said the burden of funding the future spending commitments of Wednesday will fall most heavily on younger workers, as the population ages and retirement grows.

“Young people have reason to feel aggrieved by policies such as the triple lock that ratchets up state pensions year after year (8.5% in this budget statement) while their own incomes are eaten away by both inflation and higher taxes through fiscal drag,” he said in an email.

The U.S. may be about to hit its debt ceiling.

Treasury Secretary Janet Yellen said last week that the U.S. would likely hit the ceiling Thursday. Absent steps taken by Congress, the event may “cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability,” she wrote in a letter to new House Speaker Kevin McCarthy, R-Calif.

Here’s what the debt ceiling is, and what makes it so important for consumers.

The debt ceiling is the amount of money the U.S. Treasury is authorized to borrow to pay its bills.

Those obligations include Social Security and Medicare benefits, tax refunds, military salaries and interest payments on outstanding national debt.

The current ceiling is about $31.4 trillion. Once it’s hit, the U.S. is unable to increase the amount of its outstanding debt — and paying its bills becomes trickier.

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“Not unlike many households, the government is reliant on debt to fund its obligations,” said Mark Hamrick, a senior economic analyst at Bankrate. “And like many households, it doesn’t have sufficient income to fund its expenses.”

The debt ceiling wouldn’t be an issue if U.S. revenues — i.e., tax proceeds — exceeded its costs. But the U.S. hasn’t run an annual surplus since 2001 — and has borrowed to fund government operations each year since then, according to the White House Council of Economic Advisers.

While the U.S. is expected to reach its $31.4 trillion borrowing cap on Thursday, this in and of itself isn’t the major issue.

The Treasury has temporary options to pay bills: It can use cash on hand or spend any incoming revenues, such as those during tax season, which starts Jan. 23.

It can also use so-called “extraordinary measures,” which free up money in the short term. The Treasury will start using such measures this month, Yellen said. They include a redemption or suspension of investments in certain federal retirement and disability funds. The funds would be made whole later.

These maneuvers are meant to prevent a potential calamity: a default.

A default would occur if the U.S. runs out of money to meet all its financial obligations on time — for instance, missing a payment to investors who hold U.S. Treasury bonds. The U.S. issues bonds to raise money to finance its operations.

The U.S. has defaulted on its debt just once before, in 1979. A technical bookkeeping glitch resulted in delayed bond payments, an error that was quickly rectified and only affected a small share of investors, the Treasury said.

However, the U.S. has never “intentionally” defaulted on its debt, CEA economists said. This outcome is the one Yellen warned would cause “irreparable harm.” The scope of negative shockwaves is unknown since it hasn’t happened before, economists said.  

“The fallout is serious,” said Mark Zandi, chief economist at Moody’s Analytics.

“It would create chaos in financial markets and completely undermine the economy,” he added. “The economy would go into a severe recession.”

An exact default date is difficult to pinpoint, due to the volatility of government payments and revenues. But it’s unlikely to happen before early June, Yellen said.

Congress can raise or temporarily suspend the debt ceiling in the interim to avert a debt-ceiling crisis — something lawmakers have done many times in the past. But political impasse calls their ability or willingness to do so into question this time around.   

If the U.S. were to default, it would send several negative shock waves through the U.S. and global economies.

Here are some of the ways it could affect consumers and investors:

1. Frozen federal benefits

Tens of millions of American households might not get certain federal benefits — such as Social Security, Medicare and Medicaid, and federal aid related to nutrition, veterans and housing — on time or at all, the CEA said. Government functions such as national defense may be affected, if the salaries of active-duty military personnel are frozen, for example.

2. A recession, with job cuts

Affected households would have less cash on hand to pump into the U.S. economy — and a recession “would seem to be inevitable” under these circumstances, Hamrick said. Recession would be accompanied by thousands of lost jobs and higher unemployment.

3. Higher borrowing costs

Investors generally view U.S. Treasury bonds and the U.S. dollar as safe havens. Bondholders are confident the U.S. will give their money back with interest on time.

“It’s sacrosanct in the U.S. financial system that U.S. Treasury debt is risk-free,” Zandi said.

If that’s no longer the case, ratings agencies would likely downgrade the U.S.’ sterling credit rating, and people will demand much higher interest rates on Treasury bonds to compensate for the additional risk, Zandi said.

Borrowing costs would rise for American consumers, since rates on mortgages, credit cards, auto loans and other types of consumer debt are linked to movements in the U.S. Treasury market. Businesses would also pay higher interest rates on their loans.

4. Extreme stock market volatility

Of course, that’s assuming businesses and consumers could get credit. There might also be a “severe” financial crisis if the U.S. government is unable to issue additional Treasury bonds, which are an essential component of the financial system, Hamrick said.

“A default would send shock waves through global financial markets and would likely cause credit markets worldwide to freeze up and stock markets to plunge,” the CEA said.

Even the threat of a default during the 2011 debt ceiling “crisis” caused Standard & Poor’s (now known as S&P Global Ratings) to downgrade the credit rating of U.S. and generated considerable market gyrations. Mortgage rates rose by 0.7 to 0.8 percentage points for two months, and fell slowly thereafter, the CEA said.