The chancellor, Jeremy Hunt has given strong hints that he wants to cut taxes in the spring budget.
Mr Hunt told the BBC that countries with lower taxes have more “dynamic, faster growing economies”.
In the autumn statement, the chancellor cut national insurance for workers by 2% and announced tax relief for businesses.
If inflation falls this year, followed by lower interest rates, Mr Hunt may have headroom for further tax cuts.
Mr Hunt was speaking during his visit to the World Economic Forum, in Davos, Switzerland, where he is hoping to lure in more investment to Britain.
He said the “direction of travel” indicates that economies growing faster than the UK, in North America and Asia tend to have lower taxes.
He added: “I believe fundamentally that low-tax economies are more dynamic, more competitive and generate more money for public services like the NHS.”
He did not offer any further detail on the scale of potential future tax cuts, as the government awaits an assessment from the Office for Budget Responsibility (OBR).
However it is widely expected that the chancellor will focus on income tax in the budget on 6 March.
Currently, the overall tax burden is on course to rise to the highest level for decades as households are pushed into higher income tax brackets as a result of tax thresholds remaining the same levels for over two years.
Usually tax thresholds rise in line with inflation, the rate at which the prices in shops increase, but they have been kept the same since 2021, and will remain frozen until 2028.
Tax cuts hinge on inflation
While it is hoped that inflation will fall as the year goes on, it unexpectedly ticked up to 4% in December from 3.9% in November.
The chancellor said he was “confident” that inflation will continue to fall and that prices were “heading in the right direction”.
He told reporters on Thursday: “I think it’s coming down. I think it will continue to fall.”
Lower inflation would help to pave the way for faster interest rate cuts by the Bank of England, as well as reducing the government’s huge debt interest bill.
In a bid to curb inflation, the Bank of England has held interest rates at 5.25% at its last three meetings, but it is expected to cut this later this year.
Lower debt interest payments alone could strengthen the chancellor’s hand in cutting taxes to the tune of almost £15bn.
However the UK still remains on the brink of recession, after official growth figures showed the UK economy shrank between July and September. A recession is usually defined as when GDP falls for two three-month periods – or quarters – in a row.
While Mr Hunt insisted that it was “too early to know the extent to which we’ll be able to cut taxes”, he said the rapid fall in inflation was a sign that Britain’s economic prospects are improving.
