Tax rates have not changed. But millions of UK workers and self-employed individuals are paying more income tax than they were three years ago. This is fiscal drag — and it is by design.
What Is Fiscal Drag?
Fiscal drag occurs when income tax thresholds remain fixed while wages rise with inflation. Even though the headline tax rates stay the same, a larger proportion of income falls within the taxable bands — so the effective tax rate increases.
In normal circumstances, income tax thresholds rise each year in line with inflation. The current government froze them instead.
The Numbers
The key thresholds, frozen since April 2022 and confirmed to remain frozen until April 2031, are:
| Threshold | Frozen at | Inflation-adjusted value (approx.) |
|---|---|---|
| Personal Allowance | £12,570 | ~£15,480 |
| Higher Rate Threshold | £50,270 | ~£61,000 |
| Additional Rate Threshold | £125,140 | N/A (introduced in 2023) |
The gap between the frozen personal allowance and what it would be if inflation-adjusted represents a tax cost of over £580 per year for basic rate taxpayers — simply because their wages went up but the tax-free amount did not.
The Office for Budget Responsibility estimates that the freeze will bring approximately 700,000 additional people into income tax by 2030/31, and push many more into the higher rate band.
Who Is Most Affected?
- Workers receiving annual pay rises — even modest inflation-linked increases push more income into the 40% band over time.
- Business owners drawing salary and dividends — the frozen thresholds affect the optimal split between salary and dividends each year.
- Those approaching the higher rate threshold — individuals earning close to £50,270 are at particular risk of crossing into the 40% band without realising.
- High earners near £100,000 — the personal allowance tapers away at £1 for every £2 earned above £100,000, creating an effective 60% marginal tax rate between £100,000 and £125,140. This band is now wider in real terms.
What Can You Do?
The freeze is law until 2031, so planning around it is the most effective response:
- Pension contributions — contributions reduce your taxable income. For those close to the £50,270 or £100,000 thresholds, increasing pension contributions can keep income within a more favourable band.
- Salary sacrifice — if your employer offers salary sacrifice for pension contributions or other benefits, this reduces your gross pay for income tax and NI purposes.
- ISA allowances — investment income and growth within an ISA does not count towards your income tax assessment. Maximising your £20,000 annual ISA allowance keeps future returns tax-free.
- Charitable giving — Gift Aid donations extend your basic rate band, which can prevent income from being taxed at 40%.
- Review your employment structure — for business owners, the right mix of salary, dividends, and pension contributions can significantly reduce your overall tax burden.
Is fiscal drag affecting your tax bill?
A tax review can identify planning opportunities that reduce your liability within the rules. Book a free consultation with our team.