Freezing tax thresholds equal to 10p income tax hike 

Taxpayers face a huge increase in their tax bills as the government keeps tax thresholds the same despite significant increases in inflation.

New research from interactive investor reveals the true price of fiscal drag which will cost taxpayers the same as income tax rising to 25% or 30% by 2028, depending on income levels. Someone earning £20,000 will pay as much tax by 2028 as if basic rate income rose to 30%. Someone earning £30,000 or £50,000 will pay as much tax by 2028 as if basic rate income rose to 25%.

Fiscal drag works by freezing tax thresholds while wages rise with inflation. Income and National Insurance tax thresholds are due to be frozen at current levels until 2028, hitting taxpayers with a bigger tax bill as tax thresholds lag behind inflation, meaning that taxpayers pay more tax on their income as wages rise.

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Low earners on £20,000 will pay £3,762 tax by 2028, including income tax and national insurance, assuming their wages keep pace with inflation. This compares to a £3,796 tax bill in 2028 if tax thresholds kept pace with inflation, but basic rate income tax was raised to 30%.

Middle earners on £30,000 will pay £7,654 tax by 2028, including income tax and national insurance, assuming their wages keep pace with inflation. This compares to a £7,844 tax bill in 2028 if tax thresholds kept pace with inflation, but basic rate income tax was raised to 25%.

Higher earners on £100,000 pay the biggest penalty for fiscal drag because the tax rules mean they pay 60% income tax on income earned above £100k, due to losing the £12,570 tax-free personal allowance. They would not enter this tax bracket if the £100k taper-limit increased in line with inflation. They will pay £4,326 extra income tax by 2028 compared to 22/23 due to losing most their personal allowance as their wages rise with inflation.

Top earners on £150,000 will be affected by the 45% additional tax threshold being reduced and then frozen at £125,000 until 2025. By 2028 £57,000 of their income will be taxed at 45% rather than none in tax year 22/23.

This research follows this week’s IFS study which revealed one in five taxpayers will be paying higher rate tax by 2028, nearly quadrupling since the early 1990s and forcing one in four teachers and one in eight nurses into the higher rate tax bracket.

How we worked out the cost of fiscal drag

The calculations assume that wages rise with inflation between March 2023 and March 2028. Extra tax due compares tax payable in tax year 22/23 compared with 27/28.

We have calculated the tax raised if income and national insurance thresholds remain at the same rate. We have compared this to tax charged if thresholds rose with inflation between 22/23 and 27/28 and income tax rates changed to 21%/41%, 25%/45% and 30%/50%.

Alice Guy,Head of Pensions and Savings at interactive investor says,

“Hidden tax rises will decimate the finances of many families over the next few years. As if the cost-of-living crisis wasn’t enough, taxpayers are facing a massive tax-grab over the next few years as tax thresholds lag behind inflation.

“Blistering tax rises will hit lowest earners the hardest, because more of their income is tax free. Someone earning £20,000 in March 2023 only paid tax on around £7,500 (36%) of their income, whereas they’ll need to pay tax on £11,756 (48%) of their income by 2028.

“The numbers reveal the shocking truth that freezing tax thresholds is equivalent to raising income tax by 5% for most earners, and 10% for low-income earners that can afford it the least.

“Fiscal drag is largely hidden because tax is complicated and not many people check their pay slips. Many families fighting hard to make ends meet as costs rise, but fiscal drag means that the odds are increasingly stacked against them.  

“If you can afford to, then paying into your pension can be a great way to reduce your tax bill. Pension contributions are tax free, meaning that it only costs £80 to pay £100 into your pension if you’re a lower rate taxpayer and £60 to pay in £100 if you’re a higher rate taxpayer.”