Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
Fiscal drag is often called a stealth tax because it works quietly in the background. Most of the time people don’t notice it at all, until events like the Autumn Budget bring frozen tax thresholds back into the spotlight. But what is it, and how does it affect you and your money?
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1. What is fiscal drag?
Fiscal drag happens when tax thresholds and allowances don’t rise in line with inflation or wage growth. You may appear to earn more on paper, but because thresholds stay fixed, more of that income becomes taxable. This can push you into a higher tax band even though you don’t feel richer in real terms.
Freezing thresholds increases the amount of tax collected without changing the tax rates themselves. So, while your income might rise, a larger slice is taken in tax.
The table below shows the startling impact of fiscal drag since 2020, when frozen tax thresholds really began to take hold.
2. How does the government set thresholds?
The government sets tax thresholds based on a combination of economic, social, and political factors. ‘Indexation’ is sometimes used to describe when governments adjust thresholds in line with the growth of an index (such as inflation or wage growth). However, the UK government has currently chosen to freeze thresholds for years. The freeze, which was initially set to last until April 2028, has been extended to April 2031. Changes to thresholds are usually confirmed in the budget and rolled out in future tax years.
3. How can it impact you?
Fiscal drag doesn’t hit everyone the same way.
You may pay more tax over time, leaving you with less to spend or save. This can delay your progress towards long-term goals.
For example, anyone earning above £50,270 becomes a higher rate taxpayer, paying 40% on earnings above this level. Meanwhile, earning more than £12,570 can see you going from paying no tax to 20% on your earnings above the threshold. And because the thresholds are frozen, more people fall into these bands each year.
The table below shows the tax rates you pay in each band if you have a standard Personal Allowance of £12,570 (income tax bands are different if you live in Scotland).
4. How does it affect the economy?
Fiscal drag can affect the economy in different ways. When people have less money to spend, they often cut back, which can slow the economy and put pressure on jobs. It may also make people less keen to work overtime or take on extra roles.
But it can work the other way too. Fiscal drag can help cool an economy that is growing too fast by gently reducing how much people spend. And because it brings in more tax revenue, the government may have more to put towards public services or reducing borrowing.
The latest OBR estimate is that the freeze of income tax thresholds, if extended to 2030/31, will raise over £55 billion1.
5. How can you deal with it?
Fiscal drag may be a subtle and technical concept, but its effects are everywhere. It acts as a stealth tax that can re-shape your finances. However, there are some ways to help soften the blow:
- Stay informed: Keep up to date with changes in tax and thresholds to understand how they might affect your tax liabilities.
- Use your allowances: Take full advantage of all available allowances and reliefs, such as personal allowances, pension contributions, and ISA allowances, to minimise taxable income.
- Manage your income: Consider strategies to manage income growth, such as balancing income between salary, dividends and Capital Gains to use different allowances.
- Seek professional advice - speak to a tax specialist or financial adviser if you’re feeling overwhelmed and would like personalised, paid-for support.
Read: Want to be tax-efficient but don’t know where to start?
Read: Financial traps people fall into over the years
Read: Pay rise? Bonus? New tax bracket? Tax worries?
Source:
1 House of Commons Library, Fiscal drag (an explainer), (12.2025)
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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