Millions more workers have been drawn into higher tax brackets due to the freeze on income tax thresholds, a policy implemented in 2021. This fiscal drag has increased the number of higher-rate taxpayers from approximately 4.43 million in the 2021/22 tax year to a projected 7.7 million in the 2026/27 tax year.
For tax allowances and thresholds to maintain their real value relative to inflation or wage growth, they typically need to be adjusted annually. When these thresholds do not increase in line with the rising cost of living, the amount of income that can be earned tax-free or at lower tax rates diminishes. Simultaneously, if thresholds do not keep pace with wage growth, they begin to encompass a larger segment of the working population.
This phenomenon, known as fiscal drag, results in more individuals, including those with lower earnings, being subject to income tax, and an increasing number of taxpayers falling into higher tax bands.
The freeze on income tax bands, initially implemented in 2021, has led to a larger portion of individual incomes being captured by the tax system, significantly boosting government revenue. Income tax receipts for the Treasury were £226 billion in 2021/22 and are forecast to rise to £347 billion for 2026/27, an increase of £121 billion.
"The Treasury has become increasingly reliant on the revenues generated by frozen thresholds," said Shaun Moore, tax and financial planning expert at Quilter. "What began as a temporary measure has evolved into one of the most effective revenue-raising tools available to government, but the burden falls squarely on the shoulders of UK taxpayers."
Over the past two years, more than one million individuals have been pushed into the higher tax rate bracket, paying 40% on earnings above £50,270. This group is projected to constitute nearly one-fifth of the total income tax-paying population in the current financial year.
Marianna Hunt of Fidelity noted, "Higher-rate taxpayers are no longer a small group of top earners. Because of frozen tax thresholds, millions of workers bringing home what probably feels like a relatively normal income are now paying rates of tax that would once have been reserved for much higher earners."
Additionally, the number of additional rate taxpayers has climbed from half a million in 2021/22 to a projected 1.29 million in the current financial year. This increase is partly attributed to the freeze in the band at £150,000, which was later reduced to £125,140 in 2023/24, consequently drawing more individuals into the highest tax rate.
The impact of fiscal drag is not limited to higher earners. The number of basic rate taxpayers is projected to increase to 31.4 million, up from 27.4 million in 2021/22. "Almost eight million more people, or a fifth of all taxpayers, have been dragged into paying tax in the years since [2021]," Moore stated. "Much of this growth is occurring within the basic rate tax band… However, what were once considered tax rates for wealthier people are increasingly reaching a much broader group."
By the end of the current tax year, nearly a quarter of all taxpayers are expected to be over the state pension age. This trend is largely due to the personal allowance remaining frozen at £12,570, combined with the increasing value of the state pension driven by the triple lock policy.
According to figures from AJ Bell, if the higher-rate threshold had been adjusted for inflation since the 2021/22 tax year, the 40% tax band would commence at a salary level of £69,504.
Income tax thresholds were initially frozen by the Conservative government in 2021, when Rishi Sunak served as Chancellor. This freeze was scheduled to conclude in 2025/26 but was subsequently extended to 2026/27. Following the Labour party's ascent to power, Chancellor Rachel Reeves extended the freeze further, to 2030/31.