The chancellor, Rachel Reeves, has announced that income tax thresholds will be frozen until the 2030-31 tax year.
Freezing tax thresholds results in “fiscal drag” – a phenomenon where people are dragged into higher tax bands when they get pay rises.
Until 2021, the UK income tax thresholds were typically increased each year in line with inflation. When the then chancellor, Rishi Sunak, delivered his budget that year he announced that thresholds would be frozen from April 2022 until 2026.
The Conservative government extended that freeze until 2028, and now Reeves has announced it will continue until 2030.
Here we explain how the changes work, and you can use our tool to find out how much more tax you will pay over the next five years as a result of the freeze. We have used the OBR’s forecasts for inflation and applied them to earnings and thresholds.
The final figure is the amount by which your tax bill will effectively be larger in 2030, compared to what it would have been if thresholds had moved with inflation. In each intervening year the increase would be smaller, but similar.
Figures for earnings above £100,000 take into account the loss of some or all personal allowance. We have left the £100,000 threshold unchanged.
Tax thresholds
These are the point where the tax rate on your income changes. In England, Wales and Northern Ireland the thresholds are the same.
Everyone has a personal allowance of £12,570, and below that income is not taxed. Income between £12,571 to £50,270 is taxed at the basic rate of 20% if it is on earnings. Income between £50,271 to £125,140 is charged at the higher rate of 40%, and anything over £125,140 is taxed at the additional rate of 45%. There are extra charges on savings and property income.
If you earn more than £100,000 once things such as pension contributions are taken into account, your personal allowance is reduced by £1 for every £2 you earn. By the time you earn £125,140 you will get no tax-free personal allowance.
It’s important to remember that it is only the income that is over a threshold that is taxed at that rate – if, for example, you earn £60,000, only £9,730 (£60,000 minus £50,270) is taxed at 40%.
Until 2021 the thresholds were typically increased in each year’s budget. The personal allowance was boosted by more than inflation by the Conservative government, and by 2014-15 the increases had taken 2.7 million people out of taxation. The threshold for higher-rate tax to kick in was typically increased in line with September’s inflation figure.
The impact of freezing
Many people get pay rises each year in line with inflation. When tax thresholds rise at the same time, this means more of their new earnings stay at the lower rate. When tax thresholds are frozen, pay rises spill over into the next bracket. As a result you may find that you take home less of your extra earnings than you expected.
The Office for Budget Responsibility (OBR) says had the personal allowance been moved up in line with CPI inflation since 2021 and until 2030-31 it would be £4,900 higher, with the threshold for the higher rate to kick in £20,100 higher.
It says the freezes mean the proportion of taxpayers paying either higher or additional rate tax will have increased from 15% in 2021-22 to 24% in 2030-31.
The investment firm Hargreaves Lansdown has calculated that someone earning £50,000 this year will pay £8,165 more in tax between 2020 and 2031 as a result of the extension.
“It’s not just the tax on earnings that’s affected,” says Sarah Coles, the head of personal finance at Hargreaves Lansdown. “When you start paying higher rate tax, your personal savings allowance shrinks, from £1,000 for basic rate taxpayers to £500 for higher rate taxpayers, and disappears altogether for additional rate taxpayers.
“You also pay a higher rate of capital gains tax when you cross into paying higher rate tax, and your dividend tax rate rises as you cross each income band. It means everyone, whatever their income, needs to consider the steps they can take to protect themselves.”
