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UK Income Tax and Fiscal Drag: How People Keep Falling into Higher Rates

Published by Chirag
Published Date: October 3, 2023

Income tax is a tax that UK taxpayers pay on their income. The amount of income tax you pay depends on your income and the tax band you fall into. The current tax year started on April 6, 2023, and will end on April 5, 2024. Most people in the UK get a personal allowance of tax-free income, which is £12,570 in 2023/24. You pay tax on things like:

  • The first £1,000 of income from self-employment—this is your ‘trading allowance’.
  • The first £1,000 of income from property you rent (unless you’re using the Rent a Room Scheme).
  • Income from tax-exempt accounts, like National Savings Certificates and Individual Savings Accounts (ISAs).
  • Dividends from company shares under your dividend allowance.
  • Some state benefits.
  • Premium bond or National Lottery wins
  • Rent you get from a lodger in your house that’s below the rent-a-room limit.

If you only sell items or rent out property occasionally (for example, through auction websites or short-term rental apps), always check if you need to tell HMRC about this income.

What is Fiscal Drag?

Over the past four years, successive conservative leaders such as Rishi Sunak and Jeremy Hunt have opted for capped income taxes. The result of this policy is what economists call "economic contraction."

uk fiscal drag

If tax caps remain in place as the cost-of-living rises, more individuals are pushed into higher tax brackets, resulting in an additional £26 of government tax revenue for the government relative to these caps. Changing it by freezing personal income tax at £12,570 is estimated to raise billions.

How is Fiscal Drag Affecting the People in the UK?

The data reveal a greater impact of fiscal contraction due to frozen tax constraints than inflation. As individuals earn more, they are shifted to a higher tax bracket, resulting in higher taxes. The number of Britons paying income tax has risen by more than 4 million in the last three years, according to government figures. In 2021, the frozen threshold will push 1.6 million people into the top 40% tax bracket.

UK fiscal drag

This year, at least 35.9 million earners will pay an income tax of 20% because their income exceeds the £12,570 tax-free threshold, up from 31.7 million in 2020–21, according to HM Revenue & Customs. With 4 million people paying a 40% increase in tax to 5.6 million, those at the new 45% rate would double to 862,000 by reducing the threshold from £150,000 to £125,140.

Conclusion

In summary, taxes paid in the UK are paid from individuals’ income, the amount of which depends on their income and associated taxes financial deductions, financial events, occur time with inflation or income growth pushing taxpayers into higher tax brackets.

This happens when tax constraints and appropriations fail to keep pace with economic fluctuations. Over the past four years, many people have been hit by budget cuts due to the decision of successive Conservative Chancellors to freeze income tax, leading to higher tax rates.

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