Economic Policy

The Treasury's inflation stealth tax

  • Published: Dec 05, 2013
  • Author: Peter Kenway
  • Category: Economic Policy

How inflation is measured ought to be something that can safely be left to economists while the rest of us go down the pub. Sad to say, some of the detail behind the Autumn Statement shows why that trip should be postponed.

At stake is the question of whether to use CPI – the Consumer Price Index – or RPI – the Retail Price Index. There are at least three parts to this. One is the thoroughly arcane question of which is the better index number. On this one, seemingly (as it’s multiplicative) CPI wins hands down.

A second is what to include and what not (e.g. mortgage interest payments). On this, it all depends on what it is used for. As ‘the’ measure of inflation, the one at the top of the monthly bulletin from the Office for National Statistic, CPI has clearly won this one too.

As a result, many of the things that go up each year ‘in line with inflation’ have been shifted over to CPI. At the top of this list is the state pension, along with most social security benefits (although many of the latter are for the moment subject to a much tighter 1% annual cap). The Bank of England’s inflation target is set in terms of CPI. From April 2014, the income tax personal allowance will also be indexed to CPI. None of this is new, and apart from the benefit cap, little of it is contentious.

But what is crucial to understand is that while incomes and allowances set by the state go up with CPI, many of the drivers of cost that it sets go up with RPI. And according to the detailed figures behind the Autumn Statement, while CPI is forecast to have gone up 13% by April 2019, the RPI is forecast to have gone up by 23%. 

 

Who benefits from this higher rate of inflation? Well the water companies in England and Wales for one. Earlier this week, they all published their proposals for prices over the five years from 2015. All except Thames Water were promising a drop in prices before the effects of inflation were factored in. Normally that would be fine – but since they are allowed to match RPI, that would simply mean prices still going up by 10% more than the rate of inflation that most of the rest of us use.

Another group allowed to index their prices to RPI are the rail companies. Some 40% of their fares are regulated like this, the cap for which has long been RPI+1%. For 2014 this has been brought down – but it is still RPI.

Similarly, Transport for London’s current Business Plan (to 2014/15) assumes fares rising at RPI+1% although as with national rail, it is just RPI in 2014.

Until 2015/16, rents in local authority housing are allowed to go up by a maximum RPI+0.5% plus £2 a week.

Last but not least, interest payments on student loans taken out after September 2012 are indexed to RPI.

In any particular year, the difference between the two measures is pretty small (about 0.5% at the moment). But it all adds up – and as the Autumn Statement small print shows, it soon amounts to something that is not small at all.

This in short is a stealth tax – and the main beneficiaries are the state controlled monopolies, both public and privately owned.

I suppose it would hardly grab the headlines, but if politicians wanted to promise something that would make a real difference to the cost of living over the longer term, holding this lot to the rate of inflation that the rest of face would be a way to go.


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