Fiscal Drag: How Frozen Tax Thresholds Are Silently Costing You Hundreds Every Year

I asked AI to model the cumulative effect of frozen tax thresholds since 2021, and the numbers are alarming. This impacts everyone in the UK who has received any kind of pay rise in the last five years.

Since 2021/22, the government has frozen income tax and National Insurance thresholds. Combined with inflation running far above the Bank of England’s 2% target, the result is fiscal drag — silently pulling hundreds, even thousands, of pounds out of workers’ pockets every year.

1. What Is Fiscal Drag?

Fiscal drag occurs when tax thresholds are not adjusted for inflation. As wages rise to keep up with the cost of living, more of your income crosses into higher tax bands — even though your purchasing power hasn’t increased. It is effectively a stealth tax increase without any new legislation.

These thresholds have been frozen at 2021/22 levels and will remain frozen until at least 2028/29:

• Personal Allowance: £12,570 — frozen since 2021/22
• Higher Rate Threshold: £50,270 — frozen since 2021/22
• NI Primary Threshold: £12,570 — frozen since 2021/22

Before the freeze, these thresholds were routinely increased each year in line with CPI. By freezing them for seven consecutive years (2022/23 through 2028/29), the government has created a compounding tax increase that grows larger every year inflation runs above zero.

2. What Thresholds Would Be If Indexed to CPI

To understand the real cost, we need to look at what has actually happened to inflation since the freeze began:

With cumulative CPI inflation of roughly 28% since 2021/22, the thresholds today look very different from where they should be:

That £704 is the minimum extra tax every basic rate taxpayer pays in 2026/27 compared to indexed thresholds. For higher earners, the figure is significantly larger.

3. Impact by Salary Level (2026/27)

Extra tax paid at various salary levels in 2026/27, comparing frozen thresholds to CPI-indexed thresholds:

Notes: “Extra IT (frozen PA)” is the additional income tax from £3,520 less Personal Allowance. “Extra IT (frozen HRT)” applies to those above £50,270 now paying 40% on income that would have been taxed at 20%. “Extra NI” reflects the frozen NI threshold at £12,570 vs indexed £16,090, at the 8% employee rate.

Even someone on £20,000 pays nearly £1,000 more per year than they would under indexed thresholds. For those on £60,000+, the figure exceeds £2,900 per year — £244 every month vanishing from your pay packet.

4. The “New” Higher Rate Taxpayers

One of the most consequential effects is how many people have been dragged into the 40% band:

• In 2021/22, you needed £50,271+ to be a higher rate taxpayer.
• If indexed to CPI, the threshold would now be roughly £64,346.
• Everyone earning between £50,271 and £64,346 now pays 40% on income that would have been taxed at 20% under an indexed system.
• An estimated 1.5 million additional people have been pulled into the higher rate band since the freeze began.

Many of these people do not consider themselves “high earners.” In 2021, £55,000 sat comfortably in the basic rate band. Five years of inflation later, the same real-terms income is taxed as though it represents greater purchasing power. It does not.

5. Cumulative Cost Over the Freeze Period (2022–2028)

Fiscal drag compounds year after year as the gap widens. Here is the modelled cumulative extra tax for someone on £55,000 with 3% annual pay rises:

Over the full seven-year freeze, this individual will have paid roughly £3,800 in extra tax they would not have owed under an indexed system. That money was never debated in Parliament — it is the quiet arithmetic of a threshold that stands still while everything else moves.

Scaled across the UK workforce, the OBR estimates the threshold freeze will raise over £40 billion over its duration — one of the largest tax-raising measures in modern UK history, yet one most people are barely aware of.

6. What You Can Do About It

You cannot unfreeze the thresholds, but several strategies reduce the impact:

Pension Contributions

Every pound contributed to a pension reduces your taxable income. If fiscal drag has pushed you into the 40% band, you get 40% relief on contributions that bring your income back below £50,270. Someone earning £55,000 who contributes £4,730 saves £1,892 in tax.

Salary Sacrifice

Salary sacrifice arrangements (pensions, cycle-to-work, electric vehicles, childcare) reduce your gross pay before tax and NI are calculated, saving you both income tax and National Insurance — directly countering fiscal drag on both fronts.

ISA Contributions

ISAs do not reduce your income tax bill directly, but they shelter investment returns, dividends, and interest from tax entirely. Maximising the £20,000 annual allowance ensures savings returns are not further eroded by frozen investment income thresholds.

Review Your Tax Code

Check your tax code on your payslip and via your HMRC Personal Tax Account. Errors are more common than you might think — an incorrect code could mean you are overpaying beyond what fiscal drag alone accounts for.

Marriage Allowance

If one partner earns below the Personal Allowance, they can transfer £1,260 of unused allowance to the higher earner — saving up to £252 per year. You can backdate a claim for up to four years.

Stay on Top of Your Numbers

Fiscal drag makes it more important than ever to know exactly where your income sits relative to the frozen thresholds. A few practical tools help with this:

• Xero — Cloud accounting that gives you a real-time view of your income, expenses, and tax position throughout the year. Particularly useful for self-employed workers, directors, and landlords who need to track where they sit against the £50,270 higher rate threshold or the £100k Personal Allowance taper — both of which are frozen and catching more people each year.
• Vitality health insurance — If you run a business, health cover is a legitimate expense that reduces your taxable profit while giving you faster access to specialists than the current NHS wait times allow. We both receive a £100 voucher if you sign up.
• Wise — If you receive any income in foreign currency, poor exchange rates compound the fiscal drag problem. Wise gives the real mid-market rate with low fees.

These are tools we personally use or recommend. Individual circumstances vary, and what is appropriate for one person may not suit another. This is not financial advice — always consult a qualified accountant about your specific tax position and whether these tools are relevant to your situation.

The Bottom Line

Fiscal drag is a real, measurable cost hitting every UK taxpayer right now. A prolonged threshold freeze combined with the highest inflation in four decades means millions of people pay significantly more tax on income that buys them less than it did five years ago.

A basic rate taxpayer pays nearly £1,000 more per year than under indexed thresholds. A higher rate taxpayer could be losing over £3,000 annually. Over the full freeze, the cumulative cost runs into thousands per person.

Taking action — through pension contributions, salary sacrifice, and proper tax planning — is how you fight back. The thresholds may be frozen, but your response does not have to be.

Sources

• HMRC — Income Tax Rates and Personal Allowances
• HMRC — Income Tax Liabilities Statistics
• HM Treasury — Spring Budget 2021: Personal Tax Measures
• ONS — Inflation and Price Indices (CPI Data)