Frozen tax allowances and fiscal drag

Tax thresholds frozen till 2028? That’s fiscal drag in action – more tax paid without rate rises. It’s a stealthy revenue boost for HM Treasury, projected to bring in £38bn a year by 2029. Inflation and pay rises make it worse.

The freezing of tax thresholds often results in a phenomenon known as fiscal drag. When tax thresholds remain static, taxpayers find themselves paying more tax as their earnings increase, without receiving a corresponding rise in tax allowances. Consequently, more individuals are "dragged" into higher tax brackets or start paying tax for the first time, essentially functioning as a hidden or stealth tax. In the UK, several tax thresholds—particularly for Income Tax—have been frozen since April 2022 and are set to remain unchanged until April 2028.

While fiscal drag is not an unusual occurrence, its impact is influenced by three critical factors: the government's setting of thresholds and allowances, inflation, and wage growth. How these thresholds are determined is especially significant during periods of high inflation.

Adjusting tax thresholds to align with inflation or another index is referred to as "indexation." The government’s approach of increasing certain thresholds each year based on inflation is called "uprating." However, this policy is not consistently applied. When thresholds are frozen, tax revenues increase for HM Treasury without the need for any adjustments in tax rates. According to the latest estimate from the Office for Budget Responsibility (OBR), the freeze on Income Tax thresholds is projected to generate an additional £38 billion annually by 2029-30.