Fiscal drag: An explainer
Several tax thresholds have not been increased since 2022. This briefing looks at fiscal drag in the context of taxation in the UK, with a specific focus on income tax thresholds.
Not increasing the value of tax thresholds (‘freezing’ them) increases people’s taxable income without tax rates actually increasing. This results in additional revenue to the government. This phenomenon is called ‘fiscal drag’, as more taxpayers are ‘dragged’ into paying tax, or into paying tax at a higher rate.
Although fiscal drag is not uncommon, its impact depends on three elements: the setting of thresholds and allowances (also known as just ‘thresholds’), growth in prices (inflation), and growth in earnings. How thresholds are set is an important determinant of the magnitude of fiscal drag, especially if inflation is high.
How does the government set tax thresholds?The process of increasing thresholds proportionally in line with the growth of an index (such as inflation) is sometimes called ‘indexation’.
The government has a policy of increasing certain thresholds each year in line with inflation (PDF). This process is known as ‘uprating’. Uprating policies are not always observed. When thresholds and allowances are ‘frozen’, there is an overall increase in tax paid to the government without an actual increase in tax rates.
Under legislation enacted by the previous government between 2021 and 2023, a number of tax thresholds (such as income tax ones) are frozen in their cash value for the period between April 2022 and April 2028. The Labour government further extended this freeze to April 2031 at Autumn Budget 2025. Provision for this is included in the Finance Act 2026.
Fiscal drag: A sensible ‘stealth tax’?The impact of the tax thresholds freezes has been analysed by the Office for Budget Responsibility (OBR), the public finances forecaster, in multiple economic and fiscal outlooks since the first announcement in the 2021 Spring Budget. The latest OBR estimate is that the freeze of income tax thresholds until 2030/31 will raise over £55 billion in 2030/31 (PDF, Box 3.3, Table A). This includes the impact of the lowering of the additional rate threshold from April 2023.
Since freezing thresholds raises overall tax revenue without tax rates actually increasing, the policy has also been branded as a “stealth tax”, for example as reported by the Observer in its analysis of the 2022 Autumn Statement. Think tanks such as the Resolution Foundation (PDF) and the Institute for Fiscal Studies (PDF) have warned against relying on freezing thresholds for a long time as a way to raise revenue, due to the unpredictability of future rates of inflation. However, other commentators have argued there is a case for this type of tax measure. An editorial in the Financial Times in March 2022 said that they did not oppose ‘stealth taxes’ in principle, arguing that the thresholds freeze in a high-inflation environment would help raise revenue to cover the cost of Covid-19 schemes. However, they also added that, in a high-inflation environment, the reduction in the real value of people’s incomes would be felt. As the thresholds freeze got extended, media commentary has predominantly focused on the impact of the policy on taxpayers. Following the most recent extension, for example, the Guardian noted that, due to the extension of the freeze, a full-time worker on the minimum wage would pay an extra £137 a year by 2030. The Telegraph argued that earners would lose out because of the Budget due to the extension in the freeze. The Financial Times also conducted research showing a “highly uneven” impact of the impact of fiscal drag, with higher earners not facing such sharp increases in their tax rates as a result of the freeze.
What policy decisions on tax thresholds have been made since 2021? Spring Budget 2021In the 2021 Spring Budget, as Chancellor, Rishi Sunak announced the income tax personal allowance and higher rate threshold would be uprated in line with inflation for 2021/22 (following the regular uprating policy), and then remain frozen from April 2022 until April 2026.
At the time, the Office for Budget Responsibility (OBR) estimated in its Economic and Fiscal Outlook that the measure was going to raise £8 billion per year by 2025/26.
Spring Statement 2022In the 2022 Spring Statement, then Chancellor Rishi Sunak announced that thresholds at which employees and the self-employed would start paying national insurance contributions (NICs) would be aligned with the income tax personal allowance. Both were therefore raised from £9,880 to £12,570 per year. These thresholds would then remain at the same level until 2025/26, in alignment with the income tax thresholds.
In the Spring Statement, Rishi Sunak said raising the NICs thresholds would deliver an average saving to taxpayers of £330 in the year starting from July 2022. The OBR estimated in the March 2022 Economic and Fiscal Outlook that the amount saved by taxpayers would diminish year-on-year until 2025/26 due to NICs thresholds being frozen.
Autumn Statement 2022In the 2022 Autumn Statement, then Chancellor Jeremy Hunt announced the freeze of the income tax personal allowance and higher rate threshold, as well as the NICs thresholds, would be extended to April 2028 instead of ending in 2026. He also announced that the threshold at which employers start paying NICs (the ‘secondary threshold’) would be frozen at its current rate until April 2028 (PDF). Additionally, he announced that the threshold at which people start paying the 45% rate of income tax (the ‘additional rate threshold’) would be decreased from £150,000 to £125,140 (PDF).
Autumn Budget 2024At the Autumn 2024 Budget, Chancellor Rachel Reeves announced the government would not extend the freeze to income tax thresholds beyond April 2028, confirming the end-date set by then Chancellor Jeremy Hunt. In her speech, the Chancellor said the government had chosen to protect working people by deciding to not extend the freeze beyond April 2028.
Budget 2025At Budget 2025, held on 26 November, the Chancellor announced the government would extend the freeze to income tax thresholds (of both income tax and NICs) to April 2031, three years beyond the original end of the policy. In her speech, Rachel Reeves said she would implement this policy to support public services and investment in the economy.
Scope of this briefingThresholds for other taxes have been frozen (PDF) aside from income tax (for instance, certain national insurance contributions thresholds).
Since a majority of additional revenue to the government is being raised by the freezes of income tax thresholds, this briefing mainly focuses on income tax. The Library briefing National insurance contributions: An introduction has more detail about national insurance contributions.