Stealth taxes are hitting higher earners more than expected, with rising wages helping the Treasury to rake in an extra £12bn alone last year, according to the Government's spending watchdog.
The Office for Budget Responsibility (OBR) said a stronger jobs market meant more people were dragged into paying the 40p rate of income tax rate than previously thought, pushing up employee tax and national insurance revenues sharply.
Larger receipts from big banks and accountancy firms also meant the Government borrowed far less to plug the gap between tax receipts and public spending in the 2021-22 tax year.
Faster pay growth and higher employment saw the OBR underestimate its income tax and national insurance revenue forecasts by more than £40bn, according to its annual Forecast Evaluation Report.
This reflected a wrong assumption that the end of the Government's furlough scheme would lead to higher unemployment and weaker wage growth.
Tax receipts were lifted by £23.9bn as more people stayed in work, the OBR said. Officials said a further £12bn increase in receipts was largely because of “stronger-than-expected aggregate pay growth within higher tax bands as fiscal drag brought more people than anticipated into higher tax brackets”.
This helped the Treasury to borrow around £100bn less than expected in 2021-22, the OBR said.
Fiscal drag occurs when increases in tax-free thresholds fail to keep pace with inflation or pay rises, resulting in workers handing more of their earnings to the taxman.
Previous OBR research showed workers paying the 40pc rate accounted for half the growth in income tax receipts in 2020 and 2021 as more of them were dragged into paying the higher rate.
The number of people paying the 45p top tax rate has also increased over the past few years because of fiscal drag, with the £150,000 threshold frozen for more than a decade.
Jeremy Hunt set out plans in the Autumn Statement to lower this threshold to £125,140 from April, which will drag hundreds of thousands more people into paying the top rate of tax.
It formed part of a stealth tax raid that hammered workers with a six year freeze in the personal allowance and higher rate tax thresholds until 2028.
This is expected to raise an extra £26bn-a-year for the Treasury by 2028, but will be higher if pay continues to strengthen.
It came as the OBR admitted that it “significantly underestimated inflation” at the start of 2022 as well as the post-Covid rebound in the economy.
This explained “much of our £108.6bn overestimate of borrowing in 2021-22”, the OBR said, which was “a difference second only in absolute terms to the £258bn underestimate of borrowing in our March 2020 pre-pandemic forecast for 2020-21”.
It also noted that onshore corporation tax receipts were £23.1bn – or 58.6pc – higher than expected in 2021-22 compared with its March 2021 forecast.
The OBR said “a few, relatively tax-rich sectors of the economy” and “very large companies” were responsible for the better-than-expected outturn, with companies with profits of greater than £20m explaining around £18bn of the overshoot.
Carl Emmerson, deputy director of the Institute for Fiscal Studies, said raising the rate so sharply was “not risk free”.
He added: “It's clearly going to affect some investment decisions, which I think means in the medium-run it probably won't raise as much as in the short run because increasingly, it'll be taxing new investments rather than ones that have already happened.”
HMRC data show more than 60pc growth in receipts in the last fiscal year came from the banking, professional services and retail sectors which “have typically been large payers of corporation tax and performed better than the economy as a whole through the pandemic”.
By contrast, the OBR said “some of the sectors most affected by the pandemic such as hospitality, arts and entertainment were not large payers of corporation tax prior to the pandemic. Our March 2021 forecast did not sufficiently anticipate these sectoral shifts”.