Fiscal policy and the cost of living for households.

Fiscal policy, encompassing the government’s decisions on taxation, public spending, and borrowing, has been a dominant force in shaping the cost of living crisis for UK households. In the context of high inflation and a shallow recession, recent fiscal choices have aimed to provide immediate relief, manage public debt, and influence long-term economic stability, creating a complex mix of immediate assistance and future financial burden.

I. The Dual Role of Taxation Policy

Tax policy directly impacts household finances, both through the money households retain and the money available for public services.

• Income Tax Threshold Freezes (Fiscal Drag): A key fiscal measure has been the decision to freeze income tax thresholds. As wages have risen (due to inflation and a tight labour market), more people have been pulled into paying income tax, or into higher tax brackets, a phenomenon known as fiscal drag. This has been a significant source of revenue for the Treasury but acts as a hidden tax rise, directly reducing the real disposable income of many middle and low-income households, thereby exacerbating the cost-of-living squeeze.
• Targeted Tax Cuts: Conversely, the government has used targeted tax cuts, such as reductions in National Insurance Contributions (NICs), to inject money back into the pockets of working households. This aims to boost the incentive to work and provide immediate, visible relief, countering some of the effects of fiscal drag.
• Taxation of Corporations (Business Rates): Decisions regarding corporate tax, such as cuts to business rates, impact the cost structures of companies. While these measures aim to stimulate investment, they may not directly translate into lower consumer prices or higher wages, potentially favoring business profits over direct household relief.

II. Public Spending: Direct Relief and Long-Term Pressure

Public spending decisions have been split between short-term cost-of-living relief and managing the long-term strain on public services.

• Targeted Household Support: The government utilized direct cost-of-living payments (funded by increased borrowing or one-off taxes like the Energy Profits Levy) and energy bill support schemes. These measures provided essential buffers against the peak of inflation, particularly for vulnerable households, preventing a sharper drop in living standards. This spending had an immediate, positive impact on purchasing power for those in greatest need.
• The Squeeze on Public Services: The government’s adherence to fiscal rules—aiming to reduce borrowing and debt—has led to significant pressure on the budgets of most public departments. Cuts or insufficient funding increases for local councils, the NHS, and police reduce the quality and availability of essential services. For households, this means longer waiting lists, fewer social care options, and declining infrastructure, effectively creating a “hidden cost” of living that is paid for through reduced public quality rather than cash.
• Capital Spending and Investment: Fiscal policy also dictates investment in long-term growth drivers (e.g., green technology, infrastructure, R&D). Insufficient capital spending, often the first budget item cut during fiscal consolidation, sacrifices future productivity gains that are essential to sustainably lowering the cost of living over time.

III. Borrowing and Debt: The Future Burden

The relationship between government borrowing, national debt, and the cost of living is indirect but profound.

• Interest Rate Impact: High government borrowing, especially when perceived as unsustainable by financial markets, can put upward pressure on the interest rates the government must pay on its debt. Since government debt is a major driver of overall demand for money, this pressure can contribute to higher bond yields and potentially reinforce the need for the Bank of England to maintain higher interest rates, which directly translates into higher mortgage and loan costs for households.
• Future Taxation: Large national debt ultimately implies a greater need for future revenue generation. This means that today’s government borrowing used to fund current consumption or relief packages is essentially deferred taxation, placing a future financial burden on today’s younger working households.

In conclusion, UK fiscal policy has walked a tightrope, successfully cushioning the immediate impact of the cost-of-living crisis through targeted spending and tax cuts, while simultaneously contributing to the squeeze via fiscal drag and by constraining public service spending due to necessary fiscal prudence. The overall effect has been to redistribute the burden of the crisis across different income groups and across generations.