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.
If you think you’re paying a lot of tax, you’re probably right.
The UK tax burden is at its highest level since the Second World War as a share of GDP, with further tax rises already on the horizon. Over the last decade, wages have climbed, but tax thresholds have remained stuck in a deep freeze, known as fiscal drag.
Currently, higher rate income tax of 40% kicks in once you earn over £50,270. But our calculations show that the higher-rate threshold would now be £76,000 if it had risen in line with wage inflation since 2000.
But far from increasing the threshold, Chancellor Rachel Reeves announced in November that income and national insurance thresholds will remain frozen until the tax year 2030-31. The higher rate tax threshold will stay at £50,270 for a full decade.
What is fiscal drag?
Fiscal drag works by freezing tax thresholds so more of our income is dragged into higher tax brackets over time.
As our wages rise on the tide of inflation, thresholds don’t keep pace, so more of us become higher-rate taxpayers.
Fiscal drag has proved a favourite policy for successive governments because it largely flies under the radar. Despite slowly crushing our take-home pay, we’re much more likely to notice a rise in the headline rate of income tax than the gradual squeezing of thresholds.
That’s excellent news for HMRC but not so great for us if we’re trying to build long-term wealth.
This animation shows how fiscal drag has worked since 2000.
What is a high earner?
Like most countries, the UK tax system is designed so that higher earners pay more. As your salary climbs into “higher earner” territory, the slice over the higher rate threshold is charged at 40% income tax, with 2% National Insurance on top.
The problem is that being a “high earner” is subjective and the definition is gradually changing. To breach the higher-rate tax threshold has become much easier over the last 25 years.
By 2027, the IFS predicts one in four teachers will pay higher-rate tax, with one in seven adults classed as a “high earner”. OBR records show that the number of higher-rate taxpayers will soar to 7.9 million by 2030, up from just 2.9 million in 2000.
In an alternate universe, had the higher rate threshold kept pace with rising wages, it would now be £76,000, and on track to be £87,000 by 2030. Instead, it remains stuck at a modest £50,270.
This table shows the dramatic impact of fiscal drag over the last 25 years.
Let’s look at an example to illustrate the impact of fiscal drag in more detail.
In 2000, Sally earned £32,785, equal to the higher rate threshold. Over the next 25 years, she stayed in the same role and her wages rose in line with average earnings. Now in early 2026 she earns £76,337 - the increase reflects the rise in wages over 25 years, rather than feeling like a genuine pay rise.
Now for her tax bill! In 2000, Sally paid no higher rate tax as her wages equalled the higher rate tax threshold. But now in 2026 she pays higher-rate tax on 34% of her income, with a £26,089 gap between her income and the higher rate threshold.
Despite no real pay rise, a big chunk of her wages have been pulled into higher rate tax.
Escalating impact since 2020
Although fiscal drag is a long-term policy, it really got going in earnest after 2020 after the Covid pandemic left a painful £300 billion hole in government finances.
Spiralling wage inflation made fiscal drag an effective strategy, with rising wage bills pushing more income into higher tax brackets. We may have received pay rises, but our take-home pay and disposable income felt decidedly less rosy.
The table below shows the startling impact of fiscal drag since 2000, when frozen tax thresholds really began to take hold.
Here are 4 key stats on the impact of fiscal drag:
- Despite average wages more than doubling since 2000, the higher rate threshold has risen by just 53% during the same period.
- In 2000 an average earner would need to double their pay with a 101% pay rise to attract higher-rate tax, however by 2030 an average earner could trigger higher rate tax with a pay increase of just 16%.
- By 2030-31, a high earner whose wage kept pace with rising wages since 2000 could end up with nearly £37,000 and 42% of their income above the higher rate tax threshold.
- By 2030-31, the same high earner would pay an extra £7,392 in tax each year due to the frozen threshold.
How to protect your wealth
Unfortunately, we’re stuck with frozen tax thresholds until at least April 2031. And it’s not just income tax and national insurance that are rising. The deep freeze on thresholds also affects capital gains tax, dividend tax, interest and inheritance tax, where frozen and reduced thresholds are pushing up our tax bills.
If you’re facing a rising tax bill, here are some simple strategies to minimise the impact of fiscal drag and keep more of your hard-earned wealth.
- Make the most of your pension and ISA allowances to keep more of your wealth protected from capital gains tax, dividend tax and tax on interest.
- Claim available tax rebates to help trim your bill - e.g. higher earning pension savers could be owed an additional rebate on pension payments.
- Make lifetime gifts to minimise your inheritance tax bill.
- Boosting your pension contributions can help you save income tax as well as boosting your long-term wealth.
Got a burning question you want to ask? Why not drop us a line. Click here to ask your question.
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. 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). 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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