The frightening cost of scal drag
Rising in ation and frozen thresholds have raised the tax burden for millions of people
If you think your taxes haven’t risen in recent years, think again. While the headline tax rates may have stayed the same – or even fallen in some cases – the long-term freeze on tax thresholds mean you are likely to be paying far more now than a few years ago.
Research by accountancy firm Tax Bite has found that the average worker will pay nearly £50,000 more income tax over their career now compared with three years ago. The average salary rose from £30,472 in 2020 to £35,448 in the 2023-2024 tax year. That’s a 16% jump.
“However, the income tax an average earner in England would have to pay the exchequer over 48 years has increased from £172,531 to £219,633 – a £47,102 rise, or 27%,” says Mattie Brignal in The Telegraph. “The average earner must now work for over six years solely to fulfil their lifetime income-tax obligations, six months more than in 2020-2021.”
The reason for the huge rise in the amount of income tax you are paying is frozen tax thresholds – known as fiscal drag. Since 2021 the personal allowance – the amount someone can earn tax-free – has been £12,570. The higher-rate threshold has also remained at £50,270. The government plan to keep these thresholds at the same level until at least 2028.
So, while incomes have risen, the level when you start paying different levels of tax have not, and this has dragged millions of people into paying more tax.
A wider tax base
“Higher inflation typically equals higher wages, which will push more people into the next tax bracket,” Laura Suter, head of personal finance at AJ Bell, told FT Adviser. “Had income-tax bands been linked to inflation, rather than frozen, we’d have seen a sizeable leap in the amount people could earn each year before hitting the next tax bracket.”
If the thresholds had climbed with inflation the personal allowance would be £16,341 in the 2027-2028 tax year, according to the London School of Economics. As it is, 4.5 million more people pay income tax than in 2010. At the same time far more people are now paying the bigger income-tax rates.
In 2010 10.4% of taxpayers were in the higher- or additional-tax bracket, a figure that rose to 18% in the last tax year. The tactic of freezing thresholds so more people are pulled into paying tax is making the government a fortune.
By freezing the personal allowance, the average person’s tax rate – how much of their overall income is taxed – will rise from 11.6% in 2021-2022 to 13.6% in 2027-2028 as more of their income is taxed. If the government increased the personal allowance and higher-rate threshold in line with inflation, then they would have to raise income tax from 20% to around 23.5% to bring in the same amount of tax as they are receiving through fiscal drag. “Imagine the uproar if the government had increased the basic rate of tax from 20% up to 23.5%,” says Suter. This way the government can massively increase its tax take, but without most workers being aware they are paying more tax. It isn’t just income tax that we are all paying more of. The freeze on the inheritance-tax (IHT) threshold is also raking in cash.
The main IHT allowance has been frozen at £325,000 since 2009 and will remain the same until at least 2028. If it rose in line with inflation the allowance should be worth £458,931 by 2028, according to Rory Poulter in the Daily Express.
“As a result, families will fork out an extra £53,000 on average in 2028-2029 alone.” The frozen IHT allowance is expected to bring in an extra £6bn for the government, according to Poulter.
One particularly unfortunate freeze is the gifting allowance related to IHT– the amount people may give away each year without incurring a charge. This has remained frozen at £3,000 since 1981. If inflation had been consistently taken into account since then, you would now be able to give away £11,000 a year and it would be immediately excluded from your estate for IHT purposes.