Fiscal drag due to cost taxpayers up to £4,000 by 2027

With tax thresholds increasingly becoming part of the political agenda, new research from interactive investor reveals that fiscal drag will cost the equivalent of £4,000 each year (£1,967 extra tax and £2,075 lost child benefit) for high earners with children by 2027. Key data is as follows:

• High earners with £50,000 salary in 2022 due to pay £1,967 extra tax each year by 2027 with frozen tax thresholds, compared to if the thresholds rose with inflation.
• Middle earners with £30,000 salary in 2022 due to pay £889 extra tax by 2027 with frozen tax thresholds, compared to if the thresholds rose with inflation.
• Low earners with £20,000 salary in 2022 due to pay £889 extra tax by 2027 with frozen tax thresholds, compared to if the thresholds rose with inflation.
• A high earner with two children would also lose £2,075 in child benefit by 2027 due to the high-income child benefit charge. They would lose all their child benefit by 2027 as their salary rose with inflation, but the £50,000 tax threshold remains the same.

Fiscal drag costing us dear

Assumptions: inflation based on actual CPI figures for March 2021 and Bank of England August forecast for Q1 2024 and Q1 2025, then assumed to be 2%.

How we worked out the cost of fiscal drag

The calculations assume that wages rise with inflation between March 2023 and March 2027. We have calculated what would be payable instead if tax thresholds rose by inflation until 2027-28.

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Alice Guy,Head of Pensions and Savings at interactive investor, says: “Fiscal drag is a silent and ruthlessly efficient way of raising the tax burden over time. It works by freezing tax thresholds so that we pay tax on more and more of our income as our wages rise with inflation. It’s less obvious than raising tax rates, but potentially has an even bigger impact on taxpayers over time.

“Frozen tax thresholds affect all of us, not just higher earners, because the frozen personal allowance means even lower earners gradually pay tax on more of their income.

“If you’re a parent, then fiscal drag is potentially even more painful, as you could stand to lose child benefit as your wages gradually rise with inflation. The threshold for the high-income child benefit charge has remained frozen at £50,000 since it was first introduced in 2013, drawing more and more families into the charge.

“If you can afford to, one of the best ways to minimise your tax bill is to pay more into your pension. Pension payments receive tax relief, meaning you can claw back any income tax paid on your contributions as the taxman will pay tax relief straight into your pension. This means it only costs £80 to pay £100 into your pension and £60 to pay in £100 for higher-rate taxpayers.

“Some employers also offer salary sacrifice, which means you can pay your salary directly into your pension, with no tax at all being charged. This is a great option, as you’ll save on National Insurance as well as income tax, meaning it will only cost £68 to pay £100 into your pension for basic-rate taxpayers and £58 to pay in £100 for higher-rate taxpayers.”