Fiscal Drag
The effect of frozen tax thresholds combined with wage growth, causing more people to pay higher rates of tax over time.
Key Points
- ✓Tax thresholds frozen while wages rise with inflation
- ✓Brings more people into higher tax bands
- ✓Personal Allowance and thresholds frozen until 2028
- ✓Often called a 'stealth tax'
- ✓Estimated 3.2 million more Higher Rate Tax payers by 2028
Detailed Explanation
Fiscal Drag occurs when tax thresholds are frozen while wages increase with inflation. This pulls more people into higher tax bands and increases the overall tax burden without any official rate changes.
The UK government has frozen the Personal Allowance at £12,570 and the Higher Rate Tax threshold at £50,270 until 2028. With wages rising due to inflation, more people are being 'dragged' into paying more tax.
For example, if wages rise 5% but thresholds stay the same, someone earning just under £50,270 could be pushed into the Higher Rate Tax band, suddenly paying 40% on some of their income instead of 20%.
Fiscal Drag is sometimes called a 'stealth tax' because it increases tax revenue without the government having to announce a tax rise. The Office for Budget Responsibility estimates it will bring an additional 3.2 million people into the Higher Rate Tax band by 2028.
This particularly affects middle earners and those close to threshold boundaries. It also gradually increases the proportion of income tax paid by the freezing of the Personal Allowance, as the tax-free amount becomes a smaller proportion of average earnings.
Practical Examples
- •Someone earning £50,000 in 2021 was below Higher Rate Tax. With 15% wage growth to £57,500, they now pay 40% on £7,230
- •Personal Allowance of £12,570 was 43% of median full-time earnings in 2021. By 2028, it will be only 33% of median earnings
- •A nurse getting annual 5% pay rises from £45,000 in 2021 will exceed the Higher Rate Tax threshold by 2024 without any promotion
Frequently Asked Questions
Related Terms
Personal Allowance
The amount of income you can earn tax-free each year (£12,570 for 2024/25), reduced if you earn over £100,000.
Higher Rate Tax
Income Tax charged at 40% on income between £50,271 and £125,140 (2024/25).
Basic Rate Tax
Income Tax charged at 20% on income between £12,571 and £50,270 (2024/25).
Income Tax
A progressive tax on your earnings, charged at 20%, 40%, or 45% depending on your income level (after personal allowance).
Marginal Rate
The rate of tax you pay on your next pound of income, which can be higher than your effective rate due to allowance withdrawal.