Fiscal drag race set to cost middle-earners an extra £1,900

The figure rises to £15,000 for top earners, interactive investor calculations reveal.

The potential freezing of income tax and National Insurance thresholds until the end of the 2028-29 tax year could add over £1,919 to the income tax bill of the average worker, rising to almost £15,000 for top earners, according to new calculations by interactive investor.

Ahead of the Autumn Statement, the prime minister and the chancellor are thought to have agreed to extend a freeze on the threshold where you start paying income tax and National Insurance – both at £12,570 – that had been due to end in 2026 - to 2028.

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The freezing of the income tax threshold and wage inflation have pushed a large number of workers into higher tax brackets. But wage growth continues to trail behind runaway inflation, which returned to a 40-year high of 10.1% in September, leaving less money in our pockets and making it harder to save and invest to build wealth.

Known as ‘fiscal drag’, this is the ultimate stealth tax, creating a situation where workers pay more taxes and have less purchasing power, even when earning more.

Using inflation forecasts from consultancy group EY, interactive investor calculates that a worker on £30,000 would pay an additional £1,919 in tax between the current tax year and to the end of the 2028-29 tax year if income tax thresholds remained unchanged.

A worker earning £50,000 could pay £4,280 more, while a worker on a £150,000 salary could pay an extra £14,624 in tax.

Meanwhile, those earning £20,000 could see their tax burden massively increase from 12% to 15% of take-home pay. They face paying an extra £1,267 in tax.

EY predicts CPI inflation will average at 8.9% in 2022, 5.5% in 2023 and fall below the Bank of England’s 2% target (to 1.8%) in 2024. interactive investor’s calculation assumes inflation will hover around the 2% mark from 2025 to 2028.

Alice Guy, Personal Finance Expert, interactive investor, says: “Fiscal drag is the ultimate stealth tax as it makes sure the taxman takes more and more of our money as our wages grow with inflation.

“Because Sunak is apparently planning to keep tax thresholds the same until 2028 to help balance the public finances, this means we will end up paying significantly more tax over the next few years. That’s because each time our pay goes up with inflation, a big chunk of that rise is gobbled up in excess tax.

“By 2028, someone earning £30,000 will be paying £1,919 more tax and someone earning £50,000 will be paying £4,280 more tax.

“Workers earning a similar amount to the current tax thresholds will be the worst affected, as much more of their income will be dragged into the higher tax bracket. The tax burden of someone earning £20,000 will increase from 12% to 15% of their income by 2028, and someone earning £50,000 will be spending 27% of their income on tax by 2028 rather than 24%.”

Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “Fiscal drag can be painful for consumers, and it comes as the government grapples with struggling public finances – there are no easy answers. Freezing the income tax threshold and allowing inflation to drag workers into higher tax brackets is the oldest trick in the book and will go some way in helping the government plug the gaping black hole in its finances. It is a less controversial strategy when real wages are on the up, but amid the biggest fall in living standards in generations, with the Bank of England warning that the UK is facing its longest recession since the Great Depression, a century ago, it is for a tough pill for workers to swallow – and nobody said it was going to be easy.

“Everyone will be paying more if the income tax threshold remains frozen until 2028, but the fiscal drag hits some taxpayers harder than others with the wealthiest face paying an extra £14,624 in tax. However, it is also telling that those on opposite end of the income spectrum also face a significant tax squeeze from 12% to 15% of take-home pay over the period. The lowest earners could also find themselves paying higher taxes if employment-conditional benefits like tax credits are not adjusted to take account of inflation. Fiscal drag can erode the value of such benefits.

“The freezing of income tax threshold and other personal allowances has bolstered the allure of employment salary sacrifice schemes, as they can be used to offset the rise. This arrangement allows employers to reduce employees’ salary and pay the equivalent amount into a non-cash benefit such as pension contributions and a cycle-to-work scheme. Think of a pension as deferred income and this seems like a good way to reduce your overall NI bill without reducing your income, if you are happy to take it after age 55 instead.

“As the coming years are wrought with uncertainty for personal finances, people will want to keep an eye on costs more than ever. For investors, checking investment charges is part of the parcel. It’s worth making sure your investment platform is delivering value, and that your funds are too.”

Source: interactive investor