The cuts to National Insurance (NIC) contributions come into effect today, saving the average worker £450 a year.
Around 27 million people will see a 2p cut on their NICs after Chancellor Jeremy Hunt cut the rate from 12 per cent to 10 per cent in last November's Autumn Statement.
The Treasury claimed that cutting contributions would save workers hundreds of pounds a year, ending speculation that it would cut income tax.
Tax cut: Hunt cut NI contributions from 12% to 10% in a bid to boost growth
While there may be further cuts in the March budget, today's NI cut means a significant tax cut for millions of people.
But who will benefit from these changes, and will workers really be better off if the stealth freeze on tax thresholds drags more people into higher tax brackets?
Who benefits from cuts to National Insurance?
The Chancellor has made sweeping changes to the way both employees and the self-employed pay for national insurance.
However, today's changes will only apply to employees. The changes for the self-employed – including the abolition of class 2 premiums – will come into effect in April.
Like income tax, NI is a fixed percentage that comes out of your wages. Employers also have to pay premiums.
It means that a reduction in NI will mirror the effect of an income tax cut and increase take-home pay for employees.
However, it will not have the same impact on people over state pension age as they do not pay NI.
However, in the Autumn Statement, Hunt confirmed that people over 66 will see their state pension increase by 8.5 percent thanks to the triple lock.
How will a reduction in national insurance affect your net salary?
Calculations from wealth manager Quilter estimate that a taxpayer with an average salary of £34,963 could save almost £450 a year from a 2 per cent cut to NI.
At the previous level of 12 per cent, workers were taxed £2,687.16 per year in NI alone, which now falls to £2,239.30, saving £447.86.
Workers on £30,000, who previously paid £2,091.60 in NI per year, will have an extra £348.60 in their pockets, while those earning £40,000 will save £548.60.
A worker with £100,000 will save £754, but the inability to address the marginal income tax traps means that the next pound they earn above that will face an effective marginal income tax rate of 60 per cent due to the abolition of the personal income tax deduction.
Workers in London, where the average salary is £44,370, are expected to save £636 a year.
In Yorkshire, where the average salary is £31,920, workers will pocket an extra £387, while those in the North East will save £372.60.
Beware of the stealth tax
While workers may welcome a tax cut, frozen income tax thresholds have led to a massive stealth tax attack on people's incomes, according to the Institute for Fiscal Studies.
Keeping the income tax threshold frozen at the basic rate, rather than raising it in line with inflation, will see more of people's income hit the 20 percent tax levy.
If we keep the point at which people pay 40 per cent tax at the current threshold, it means that those whose pay rise gives them more than £50,270 will see their income tax on the extra money double.
Although NICs have been reduced to 10 per cent, the threshold for when you start paying remains frozen until April 2028.
The reality is that employees will only be £2.68 a week better off, according to Quilter.
Shaun Moore, tax and financial planning expert at Quilter, said: 'The reality is you only benefit about 50 per cent of this due to the frozen tax bands and the tax drag.
'Assuming tax bands have risen by 2 per cent over the past four years, someone earning £34,963 would be a further £308.40 better off.
'So if you subtract this from the current tax savings, it actually amounts to a saving of £139.46 per year, or a rather measly £2.68 per week.'
Workers on the cusp of the 20 or 40 percent tax bracket are likely to be hardest hit by the changes.
Sarah Coles, head of personal finance at Hargreaves Lansdown, said: 'Those who have been dragged into paying income tax by the freeze on thresholds will be worse off – because there were no taxes on their income before all this.
'By the time these thresholds are lifted, another four million people will be paying income tax.
'Some people with higher incomes will also pay more taxes next year. This includes those who have had fairly large pay increases, moving them from basic tax to a higher tax rate – with the additional tax from the 40 percent rate and 2 percent National Insurance more than offsetting the tax savings on social security. part of their income, where they pay a basic rate of tax and NI of 10 per cent.'
What is a budgetary constraint?
Fiscal drag is the phenomenon whereby employees pay income tax for the first time, or move up a bracket as incomes rise.
Normally the government uses September's inflation rate to determine the personal allowance and income tax brackets for the following April.
It would have meant a 6.7 percent increase in the amount taxpayers can earn tax-free, and a similar increase in the basic rate before the 40 percent income tax comes into effect.
Instead, the tax thresholds will be frozen until the 2027/2028 tax year.
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