Tax Planning: Fiscal Drag Explained — How Frozen Thresholds Are Costing UK Taxpayers Thousands in 2025/26

Fiscal drag — sometimes called 'bracket creep' or 'stealth tax' — occurs when tax thresholds are frozen or rise more slowly than wages and inflation. In a properly indexed system, thresholds would increase each year in line with CPI or average earnings, so that a worker on the same real income pays the same proportion in tax. When thresholds are frozen, wage growth alone pushes taxpayers into higher bands.

The mechanics are straightforward. If you earned £50,000 in 2021/22, you sat just below the higher rate threshold and paid basic rate tax on most of your income. If your salary has grown by 5% per year since then — a reasonable estimate given ONS data — you now earn around £63,800. You are now a higher rate taxpayer, paying 40% on roughly £13,500 of your income that would have remained in the basic rate band had thresholds kept pace.

This is not a hypothetical scenario. According to HMRC statistics, the number of higher rate taxpayers has risen from 4.4 million in 2021/22 to an estimated 6.3 million in 2025/26. That represents nearly 2 million additional people paying 40% tax — not because the Chancellor raised rates, but because thresholds stood still while wages moved.

The Personal Allowance — the amount you can earn before paying any income tax — has been fixed at £12,570 since April 2021. Had it risen with CPI inflation (which averaged roughly 5.8% per year over the period), it would stand at approximately £16,600 in 2025/26. Had it tracked average earnings growth instead, it would be closer to £15,900.

That gap of £3,000-£4,000 represents real money. A basic rate taxpayer loses 20% of the shortfall — around £660 per year. A higher rate taxpayer loses 40%, or roughly £1,320 per year. For Scottish taxpayers in the advanced or top rate bands, the cost is even higher.

Cumulatively, over the five years of the freeze, a higher rate taxpayer has paid an estimated £4,000-£5,000 more in income tax than they would have done under an indexed system. This is money that has never appeared on a budget scorecard as a 'tax rise' because, technically, rates have not changed.

The freeze also affects National Insurance thresholds. The NI Primary Threshold, frozen at £12,570 since April 2022, means more of each pay rise is captured by both income tax and National Insurance simultaneously. For a worker earning £30,000, the combined effect of frozen income tax and NI thresholds costs roughly £900 more per year compared to an indexed system.

Fiscal drag does not affect everyone equally. Certain income ranges face disproportionate impacts due to the structure of the UK tax system.

The new higher rate taxpayers (£45,000-£55,000): This group has seen the most dramatic change. Workers in professions such as nursing (senior band), teaching, policing, and skilled trades who have received above-inflation pay awards now find themselves paying 40% on their marginal earnings. For context, a nurse on Agenda for Change Band 7 (top of scale) earns around £52,800 — comfortably above the higher rate threshold. Five years ago, the equivalent salary fell below it. For more on recent tax changes, see our Spring Statement 2026 analysis with worked examples.

The £100,000 trap (£100,000-£125,140): The Personal Allowance taper creates an effective marginal rate of 60% on income between £100,000 and £125,140. Because inflation and pay rises have pushed more workers above £100,000 — particularly in London and the South East — far more people now fall into this punishing band. Making pension contributions via salary sacrifice is one of the most effective strategies for managing this trap.

Scottish taxpayers: Scotland's six-band income tax system means fiscal drag operates through more thresholds. The Scottish starter rate band (19%) runs only from £12,571 to £14,876, and the basic rate (20%) from £14,877 to £26,561. With earnings growth, Scottish workers cross multiple band boundaries faster. A Scottish worker on the median salary of £33,000 is already paying the intermediate rate (21%) on part of their income — and any pay rise pushes more earnings into that 21% band or even the 42% higher rate band (above £43,662).

Part-time workers and second earners: Many part-time workers who previously earned below the Personal Allowance now pay income tax for the first time, despite having no greater purchasing power. This particularly affects women returning to work and those in lower-paid sectors where nominal wages have risen with the National Living Wage.

Several macroeconomic trends are compounding the fiscal drag effect in 2025/26, making it more severe than when the freeze was first announced.

Persistent earnings growth: The Annual Survey of Hours and Earnings (ASHE) shows median full-time earnings have grown from approximately £31,300 in 2021 to an estimated £38,500 in 2025 — a rise of 23%. This earnings growth, while welcome in isolation, is the engine that drives fiscal drag.

Iran conflict and energy costs: The escalation of the Iran conflict has pushed oil prices above $100 per barrel again, feeding through to UK petrol, heating, and manufacturing costs. The Bank of England's latest projections suggest CPI inflation will remain above its 2% target through 2026, with energy costs a primary driver. Higher inflation forces employers to offer larger pay rises just to maintain workers' real spending power — and those pay rises are then captured by frozen thresholds. For a broader view of the Chancellor's recent decisions, see our Spring Statement overview.

The OBR's numbers: The OBR's income tax analysis estimates that the threshold freeze raises approximately £7 billion per year in additional revenue by 2025/26 — rising to over £8.5 billion by 2027/28 when the freeze is scheduled to end. Over the full freeze period (2022/23 to 2027/28), the cumulative extra revenue is projected at around £40 billion.

To put this in perspective, £7 billion is more than the entire annual budget of the Ministry of Justice. The threshold freeze is one of the single largest revenue-raising measures in modern British fiscal history — yet it has never been voted on as a tax increase.

While you cannot change government policy, there are legitimate and effective strategies to mitigate the impact of fiscal drag on your finances. Visit our tax hub for a full range of guides.

1. Maximise pension contributions: Every £1 you contribute to a pension via salary sacrifice reduces your taxable income by £1. If fiscal drag has pushed you into the higher rate band, a pension contribution that brings your taxable income back below £50,270 effectively reclaims the entire 40% marginal rate. For someone earning £55,000, a salary sacrifice pension contribution of £4,730 would bring them back to basic rate — saving £946 in income tax alone, plus National Insurance savings of around £95. Our salary sacrifice guide explains the mechanics in detail.

2. Use your ISA allowance: The annual ISA allowance remains £20,000 for 2025/26. While ISA contributions do not reduce your income tax bill directly, they shelter future investment returns from both income tax and capital gains tax. In an environment where fiscal drag is already biting, ensuring your savings and investments grow tax-free inside an ISA becomes more valuable than ever.

3. Claim Marriage Allowance: If one partner earns below the Personal Allowance (£12,570) and the other is a basic rate taxpayer, the lower earner can transfer £1,260 of their unused allowance. This saves the recipient £252 per year — and you can backdate claims by up to four years, potentially recovering over £1,000.

4. Navigate the £100k trap: If your income is between £100,000 and £125,140, the effective 60% marginal rate makes pension contributions extraordinarily tax-efficient. Every £1 of salary sacrificed in this range saves you 60p in income tax plus 2p in NI — a total tax saving of 62%. Even modest additional pension contributions can make a substantial difference.

5. Consider timing of bonuses and income: If you have flexibility over when you receive bonuses, commissions, or freelance income, timing can matter. Spreading income across two tax years can sometimes keep you below a threshold in both years rather than breaching it in one.

6. Review your tax code: HMRC's estimates are not always correct. Check your tax code on your payslip or through your Personal Tax Account. Errors in tax codes can compound the effects of fiscal drag, and claiming allowances you are entitled to — such as professional subscriptions or working-from-home relief — helps offset the creep. For broader tax-reduction strategies, see our inheritance tax planning guide, which covers allowances and reliefs that interact with income tax planning.

For more on this topic, see our guide to Wills, Probate, and Protecting Your Family's Future in 2025/26.

The current policy is for thresholds to unfreeze from April 2028, at which point they would resume rising in line with CPI. However, there are reasons to be cautious about assuming this will happen on schedule.

First, the government has already extended the freeze once. It was originally announced to run until April 2026 and was then pushed back to April 2028 in the Autumn Statement 2023. With public finances under pressure — partly due to increased defence spending linked to the Iran conflict — there is a realistic possibility of a further extension.

Second, even when thresholds do unfreeze, they will not 'catch up'. If the Personal Allowance resumes CPI-indexation from £12,570 in April 2028, it might rise to around £12,900. But had it been indexed throughout, it would be approximately £17,500 by then. The gap of nearly £5,000 is permanent — a structural increase in the tax burden that will persist indefinitely unless a government explicitly legislates a catch-up adjustment, which no major party has proposed.

Third, the freeze has created a political dynamic where any future government that does raise thresholds can claim credit for a 'tax cut' — even if they are merely restoring the status quo ante. This makes it politically attractive to keep thresholds low and offer targeted adjustments rather than wholesale indexation.

For now, the prudent approach is to plan on the assumption that thresholds will remain at current levels through 2027/28 and that any post-freeze rises will be modest. Building tax efficiency into your financial planning — through pensions, ISAs, and careful income management — is the best defence against a policy environment where fiscal drag has become a permanent feature of the UK tax landscape.

To illustrate the real-world impact, consider three workers who each received 5% annual pay rises since 2021/22, compared to what they would pay under an inflation-indexed threshold system.

Worker A — Starting salary £25,000 (now ~£31,900): Under frozen thresholds, income tax in 2025/26 is approximately £3,866. Under CPI-indexed thresholds (PA of ~£16,600, basic rate band up to ~£53,300), the bill would be roughly £3,060. Annual cost of fiscal drag: approximately £800.

Worker B — Starting salary £45,000 (now ~£57,400): Under frozen thresholds, they now pay higher rate tax on roughly £7,100 of income. Their total income tax bill is around £10,416. Under indexed thresholds, their entire income would remain in the basic rate band, with a bill of roughly £8,160. Annual cost of fiscal drag: approximately £2,250.

Worker C — Starting salary £80,000 (now ~£102,100): This worker has been dragged into the £100,000 PA taper zone. Their effective marginal rate on the last £2,100 of income is 60%. Under an indexed system where the PA taper started at around £130,000, they would face no taper at all. Annual cost of fiscal drag: approximately £3,600.

These figures represent the annual cost in 2025/26 alone. Cumulated over the five years of the freeze, the total additional tax paid ranges from roughly £2,500 for Worker A to over £12,000 for Worker C. For a household with two earners in the higher rate band, the combined cost can exceed £20,000 over the freeze period.

Visit our pensions hub for strategies on reducing your taxable income through retirement savings — one of the most effective tools against fiscal drag.

This article is for informational purposes only and does not constitute regulated financial advice. The value of investments can go down as well as up, and you may get back less than you invest. Tax rules and thresholds can change — always check the latest figures on GOV.UK before making financial decisions. For personalised advice, consult an FCA-regulated financial adviser via Unbiased or the MoneyHelper adviser directory.