Big squeeze hits middle classes and rich

New research reveals the best-off will see their spending power cut by as much as 9 per cent, almost £5,000 a year, the most vicious assault on their living standards in three decades.

Next year, Britain's middle classes and the rich will face the biggest squeeze on their living standards in decades, shows research produced by accountants PricewaterhouseCoopers for The Independent.

In the build-up to what promises to be an exceptionally tough pre-Budget report this Wednesday, PwC says the typical British family ("Middle England") already faces a decline of 2.4 per cent, or £300 a year, in its discretionary spending power, after tax, mortgages, food and other essentials.

The best-off will see their spending power cut by as much as 9 per cent, almost £5,000 a year, the most vicious assault on their living standards in three decades. The impact of swingeing income tax and national insurance hikes, VAT increases, expected moves back to more normal mortgage rates and higher petrol and transport costs, thanks to the latest boom in world oil prices, will all conspire to devastate the household budgets of the better-off.

And it may well get worse. The research is based on existing, declared future tax plans. Rumoured moves by the Chancellor, Alistair Darling, to "soak the rich" in this week's pre-Budget report by reversing cuts in inheritance tax and taxing bankers' bonuses will only add to the agony of the well-heeled.

But some ministers may be pleased to learn that the PwC research also says this "progressive" change in the distribution of incomes means that the worst-off in British society will actually see their spending power rising next year: a single mother on about £10,000 a year will be 2.3 per cent better off in terms of discretionary spending, about £130 a year.

Such a marked redistribution of income, partly engineered via the tax system, chimes well with the Government's present political message. John Hawksworth, the head of macroeconomics at PwC, said: "The most striking result is the sharp projected squeeze on discretionary spending for a high-earner, hit both by higher taxes and a potential marked rise in mortgage interest payments in 2011-12, as well as by higher petrol prices. This is despite them having assumed a somewhat greater increase in gross income over this period than the other households."

He went on: "The outcome appears relatively progressive, with the highest earners being hit hardest and a single working parent being relatively well protected from the squeeze."

A typical middle-income family, on about £30,000 with two young children and one partner not working, says PwC, will also see their discretionary spending squeezed due to higher mortgage interest payments and petrol costs as well as the planned rise in national insurance contribution rates from April 2011. But the scale of the squeeze, at 2.4 per cent, is much smaller than for a high-earner since tax rises are much less pronounced for middle-earners, and they are likely to have a significantly lower mortgage. But they will also be hit by some marked increases in the cost of living: higher VAT, petrol prices, food bills, public transport fares and council tax will all take their toll.

The most dramatic and significant cost increase for many families, says PwC, will be in mortgages, where rates are assumed to pick up from an average of about 3 per cent in 2010 to 3.5 per cent on average in 2011 and 4.75 per cent in 2012.

Mr Hawksworth added: "While not large in absolute terms, these increases imply much larger percentage increases in mortgage interest payments from their present low base. This has a particularly significant effect on our high-earner, given their large mortgage, with smaller but still material effects on the discretionary spending budgets of our middle-income couple."

The best outlook is for the nation's poorest, if they are in work, reflecting rising benefit income and the fact that these households are not affected either by tax rises or by increases in mortgage interest rates, given that many are assumed to live in rented accommodation paid for in part by housing benefit. PwC uses the example of a single parent, with one young child in primary school, and who works part-time (20 hours a week) earning the minimum wage, with their income supplemented by child benefit and tax credits.

Such shifts in the distribution of income from the rich and middle-income groups to the poor mark a reversal of the recent trend. Although most researchers say New Labour did stop and reverse rising inequality in its first term of office, since then the trend has been less egalitarian, as it was under the Conservatives from 1979 to 1997.

The banks could face a windfall tax whoever takes power in next year's general election. There was speculation last night that the Chancellor will announce details this week of Labour's intention to tax the banks, and the shadow Chancellor, George Osborne, said yesterday that he "would not rule out" a windfall tax on banks' profits, but would prefer reforms that prevent them from using past losses to offset their tax liabilities. "My message is clear: when the banks start making profits again they should start paying taxes again," Mr Osborne said.

Mr Darling confirmed yesterday that he has the power to order the Royal Bank of Scotland, which is partly nationalised, not to pay bonuses, but went on to say that he is not going to stop them altogether.

The Chancellor stressed that the finance industry employs a million people in the UK, most of them outside London, and that the Government is anxious not to damage the competitiveness of British banks.

But, on BBC's Andrew Marr Show, he added: "We are not going to be held to ransom by people who believe you can pay extraordinarily high bonuses without regard to what's going on. These bonuses have to be reasonable and they have to be responsible and I think everyone has to accept that."