Freezing tax thresholds could increase tax burden for poorest workers by 107% by 2028

interactive investor experts comment on the effects of fiscal drag.

Freezing the personal allowance and the National Insurance tax threshold could increase the tax burden faced by the poorest workers by up to 107% by 2028, according to new calculations byinteractive investor.

Assuming that wages rise in line inflation forecasted by consultancy group EY, those earning an annual salary of £15,000 could see their tax burden rise from £878 from the current tax year to £1,818 by the end of the 2027-28 tax year.

The average worker earning £30,000 could pay a third more in tax, or £1,919 more in tax in pounds and pence terms.

Those earning £20,000 could see their tax burden massively increase and face paying an extra £1,266, up by 51%, while a worker earning £50,000 could pay £4,280 more (up 22%).

Alice Guy, Personal Finance Expert, interactive investor, says: “Raising the headline rate of tax is deeply unpopular, resulting in terrible headlines, bad publicity and the inevitable pressure for the government to do a U-turn. In contrast, fiscal drag is a subtle way of raising taxes, and is much less likely to meet widespread criticism.

“Most of us know the headline rates of tax, but we don’t really look at how much tax we’re paying in total and if it has risen over time.

“We often talk about how many people will be dragged into the higher rate of income tax. But it’s important to remember that fiscal drag affects all of us, even if we don’t change tax band.

“That’s because as our pay rises with inflation, more and more of our pay is taxed and our overall tax burden increases.

“Very low earners and very high earners actually face even bigger tax rises than those on average incomes. That’s because more of their income will be taxed as their pay rises but the basic tax threshold stays the same.

“If you can afford to, you can reduce your income tax burden by paying money into your pension. Pension savings are topped up by the taxman by at least 20%, meaning that it only costs a basic-rate taxpayer £80 to pay £100 into their pension.

“If you’re a higher-rate taxpayer, you can get 40% tax relief for pension payments. Paying into a workplace pension means you’ll get 40% tax relief automatically, whereas, if you pay into a private pension, you’ll need to claim back the additional 20% through your tax return.”

Fiscal drag

In the UK, workers currently pay 32% tax (20% income tax and 12% national insurance) on everything you earn over £12,570. The rates for Scotland are slightly different.

Higher earners also pay 42% (40% income tax plus 2% national insurance) on earnings over £50,270.

There are also complicated rules for very high earners who effectively pay 62% tax on earnings between £100,000 and £125,000.

There is also a 45% rate income tax on earnings over £150,000, soon to be reduced to £125,000 (still with 2% National Insurance on top).

All income tax thresholds have been almost the same since 2019 and are due to remain the same until at least 2028 (the basic threshold rose a tiny £270 in 2021).

This means we’ll all be paying more and more tax each year, as tax thresholds remain the same for another six years, while our pay and everything else around us goes up with inflation.

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.

Fiscal drag affects all of us, even if we don’t change tax band. That’s because as our pay rises with inflation, more and more of our pay is taxed and our overall tax burden increases.

Commenting, Myron Jobson, Senior Personal Finance analyst, interactive investor, says: “Fiscal drag is a sneaky yet effective way of reducing the budget deficit, but this strategy is set to intensify the tax burden of workers who can least afford it.

“The recent hike in the minimum wages does little to offset the mushrooming tax burden for the poorest workers resulting from fiscal drag until 2028. The uptick in wages is essentially top-sliced through tax as wage inflation will suck more and more people into the higher-rate tax bracket.

“The freezing of income tax threshold and other personal allowances has bolstered the allure of paying into a workplace pension through salary sacrifice. This arrangement allows employers to reduce employees’ salary and pay the equivalent amount as pension contributions. Basic-rate taxpayers get 20% pension tax relief, turning a £80 contribution to £100. If you are a higher-rate taxpayer, you could reclaim an additional 20% tax on your pension contributions, for a total of 40% tax relief.

“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.”

Source: interactive investor