Tax Planning: Fiscal Drag Explained — How Frozen Thresholds Are Costing UK Taxpayers Thousands in 2026/27

Fiscal drag — sometimes called 'bracket creep' or 'stealth tax' — happens when tax thresholds freeze or rise more slowly than wages and inflation. In an indexed system, thresholds climb each year with CPI or average earnings, so a worker on the same real income pays the same real share in tax. Freeze the thresholds and pay rises alone push people into higher bands.

The mechanics are simple. Earn £50,000 in 2021/22 and you sat just below the higher-rate threshold. Grow that salary at 5% a year and you now earn about £63,800 — paying 40% on roughly £13,500 that would have stayed in the 20% band had thresholds kept pace.

This is the sixth consecutive tax year of the freeze. The Personal Allowance is still £12,570. The basic-rate band still ends at £37,700, putting the higher-rate threshold at £50,270. The 45% additional rate still starts above £125,140. And the OBR now models all of these staying put until April 2031.

The chart tells the story in one picture: the number paying 40% has climbed by roughly two million since the freeze began — not because rates rose, but because thresholds did not.

The Personal Allowance — the income you can earn before paying any tax — has been fixed at £12,570 since April 2021. Had it risen with CPI inflation over those years, it would sit at roughly £15,400 in 2026/27. The gap is more than £2,800 — every taxpayer now pays income tax on nearly £3,000 that would have been tax-free under an indexed system.

For a basic-rate taxpayer, that gap costs 20% of the shortfall — about £566 a year. For a higher-rate payer, 40% — about £1,132. Scottish taxpayers in the 42% or 45% bands lose more on every frozen pound.

National Insurance adds a second layer. The employee Primary Threshold is frozen at £242 a week (£12,570 a year), and the Upper Earnings Limit at £967 a week (£50,270). Every pay rise above inflation is captured by income tax and National Insurance at once — a combined 28% marginal rate for basic-rate employees, and 48% for higher-rate employees inside the NI band.

Fiscal drag is not evenly distributed. Four groups feel it most.

The newly higher-rate (£50,270 and above). Senior nurses, teachers on the upper pay spine, police sergeants and skilled tradespeople with overtime now cross the 40% line on part of their earnings. The OBR expects 1.2 million extra workers to join them by 2027 — people paying 40% because their pay packet grew, not because a rate changed.

The £100,000 trap (£100,000–£125,140). The Personal Allowance is withdrawn at £1 for every £2 of income above £100,000, disappearing entirely at £125,140. In that band the effective marginal rate is 60% — and 62% once 2% employee National Insurance is added. London and South East professionals are the ones most often dragged in. Our UK income tax guide breaks down every band and rate.

Scottish taxpayers. Scotland's six-band system now runs: 19% starter to £3,967 of taxable income, 20% basic to £16,956, 21% intermediate to £31,092, 42% higher to £62,430, 45% advanced to £125,140, and 48% top above that. The bottom bands widened slightly for 2026/27, but the 42% rate still starts at £43,663 of total income versus £50,270 in England. Our stealth squeeze analysis has the year-on-year detail.

Part-time and second earners. Anyone who previously sat below £12,570 and now earns above it — thanks to National Living Wage rises — pays income tax for the first time, with no more purchasing power.

Thresholds were not the only thing to move against you in April 2026. Dividend tax rates rose by two percentage points: the basic rate climbed from 8.75% to 10.75%, and the higher rate from 33.75% to 35.75%. The additional rate holds at 39.35%, and the dividend allowance is unchanged at £500 — already cut from £2,000 to £500 in recent years.

The maths matters for anyone drawing dividends from a limited company or holding shares outside an ISA or pension. A basic-rate taxpayer with £5,000 of dividends pays £483.75 in 2026/27, up from £393.75 — £90 more on identical income. A director drawing a £12,570 salary plus £50,000 of dividends pays roughly £990 more than last year.

2026/27 is therefore a double squeeze: frozen thresholds on earned income, higher rates on dividend income. If your investments sit outside an ISA, the case for sheltering them grows stronger every year — our capital gains tax guide covers the other half of that equation.

Two developments over the past year changed the outlook.

First, the end date moved. The OBR's November 2025 outlook models the Personal Allowance and higher-rate threshold as frozen until April 2031 — a full decade, not the five years first announced. The additional-rate threshold and the £100,000 taper point are frozen for the same period. Income tax is already the government's biggest revenue stream, raising an estimated £329 billion in 2025-26 — 26.7% of all receipts.

Second, the cost of changing course has risen. Bank Rate sits at 3.75% heading into September 2026, CPI inflation was 2.9% in July 2026, and long-term gilt yields were around 4.8% in June — before September's global bond sell-off pushed borrowing costs higher still. Uprating thresholds is expensive, so a government borrowing at near-5% is unlikely to volunteer it.

The direction is one-way. The next fiscal event is more likely to extend the freeze than unwind it.

Policy is what it is. Here is what still works within it.

1. Salary sacrifice into your pension. Every £1 you sacrifice reduces your taxable income by £1 — and your National Insurance too. If fiscal drag has pushed you over £50,270, a contribution that brings you back under it reclaims the entire 40% marginal rate. Someone on £55,000 sacrificing £4,730 gets back below the threshold, saving £946 in income tax plus about £95 in NI. Our salary sacrifice guide runs through the mechanics.

2. Kill the 62% trap. Between £100,000 and £125,140, every £1 of salary sacrificed saves 60p of income tax plus 2p of NI. No other legal move in the UK tax system returns 62% instantly. Our pension tax relief guide covers the higher-rate detail.

3. Use the £20,000 ISA allowance. ISAs do not cut this year's income tax bill, but they stop future dividend and capital gains tax — which now bite harder after the April 2026 dividend rise. In a frozen-threshold world, tax-free growth is worth more each year. Start at our tax hub for the full map.

4. Claim Marriage Allowance. If one partner earns below £12,570 and the other is a basic-rate taxpayer, transfer £1,260 of unused allowance. That saves £252 a year — and you can backdate up to four years.

5. Time your income. Bonuses, commissions and freelance income you can move across a 5 April boundary sometimes keep you below a threshold in both years rather than breaching it in one.

6. Check your tax code. HMRC estimates are frequently wrong. Check your payslip or Personal Tax Account — an overpaid code compounds fiscal drag every month you do not catch it.

If you are near £60,000, see the child benefit guide: the High Income Child Benefit Charge is fiscal drag by another name.

On current policy, thresholds unfreeze from April 2031. Do not assume that means relief.

First, the freeze has already been extended more than once — from April 2026 to 2028, and now to 2031 in the OBR's outlook. A decade of frozen thresholds is itself a standing invitation to extend again.

Second, even when indexation resumes, there will be no catch-up. If the Personal Allowance simply rises with CPI from £12,570 in 2031, it never recovers the ground lost since 2021. That gap — roughly £2,800 by today's prices and widening — is a permanent structural tax rise unless a government legislates a one-off catch-up, which none has proposed.

Third, the politics now favour keeping thresholds low. Any future government that raises them can present the move as a 'tax cut' even though it merely restores the status quo. Targeted, headline-grabbing giveaways are more likely than honest indexation.

Plan on the assumption that thresholds stay roughly where they are through the late 2020s, and build tax efficiency into your finances now. For the broader picture, see our 2026/27 stealth squeeze and income tax guide.