Fiscal drag is the polite name for the mechanism by which a government raises tax revenue without raising any headline tax rate. It works by freezing thresholds in cash terms while wages, pensions, and prices rise. Over time, more taxpayers are dragged into higher rate bands and a greater share of each pound of income falls within taxable bands. The mechanism has been the single most important feature of UK personal tax policy from April 2022 to April 2026 and is forecast to continue until April 2028.
This is the story of how a six-year threshold freeze has reshaped UK personal tax bills, told through the position of our owner-managed business and self-employed client base.
The frozen thresholds
The personal allowance has been frozen at £12,570 since April 2021. The higher rate threshold has been frozen at £50,270 over the same period. Both freezes were originally announced in the Spring Budget of March 2021 with an end-date of April 2026, and both were extended in the Autumn Statement of November 2022 to April 2028. The additional rate threshold was simultaneously lowered from £150,000 to £125,140 from April 2023 — a one-off downward step rather than an annual freeze, but with similar cumulative effect.
The inheritance tax nil-rate band has been frozen at £325,000 and the residence nil-rate band at £175,000 over the same period. The £100,000 personal allowance taper threshold — producing an effective 60% marginal rate between £100,000 and £125,140 — has been frozen since 2010.
The mechanism
When the higher rate threshold is frozen and wages rise, three things happen in sequence. Pay rises produce more taxable income at the higher marginal rate rather than the basic rate. The share of income in the basic rate band falls as a proportion of total earnings. The cash impact of a given pay rise on take-home pay is smaller than the gross figure would suggest.
For an employee earning £45,000 in April 2022, a typical sequence of wage settlements would have lifted gross pay above £50,270 within the freeze period. The first pound of pay above £50,270 attracts a 40% income tax rate plus National Insurance, where the same pound below £50,270 attracts a 20% income tax rate. The net effect is that the employee crosses into the higher rate band and pays the higher rate on every pound above the threshold for the remainder of the freeze period.
The £100,000 cliff
The most punishing fiscal drag operates between £100,000 and £125,140. The personal allowance tapers away at a rate of £1 of allowance lost for every £2 of income above £100,000. The taper produces an effective marginal rate of 60% on income in that band — 40% income tax on the additional income plus 40% income tax effectively reinstated on the personal allowance withdrawn. The £100,000 cliff has been frozen for sixteen years, and the share of taxpayers caught by it has risen substantially every year over the freeze period.
For director-shareholders managing remuneration around this band, the 60% effective rate has been the dominant planning conversation. Pension contributions, salary sacrifice, dividend timing, and gift aid have all been used to keep adjusted net income below £100,000 where possible. Our tax planning team has built £100,000 cliff analysis into every relevant personal tax engagement since 2022.
The additional rate threshold drop
The lowering of the additional rate threshold from £150,000 to £125,140 from 6 April 2023 was a single-step fiscal drag event rather than a freeze. The change brought several hundred thousand additional taxpayers into the 45% additional rate band. For director-shareholders drawing dividends, the dividend upper rate of 33.75% in 2022-23 became the dividend additional rate of 39.35% on the same band of income from 2023-24. The cash impact on a director drawing £160,000 of dividends was on the order of £1,400 per year.
The dividend and CGT allowance cuts
The dividend allowance was cut from £2,000 to £1,000 in April 2023 and to £500 in April 2024. The capital gains tax annual exempt amount was cut from £12,300 to £6,000 in April 2023 and to £3,000 in April 2024. These are not strictly fiscal drag in the threshold-freeze sense — they are cash cuts to allowances — but their cumulative effect over the period has been to remove almost the entire planning value of the allowances. The dividend allowance has effectively become rounding, and the CGT annual exempt amount has stopped meaningfully sheltering even modest disposals.
The cumulative effect
The OBR has consistently estimated that the personal allowance and higher rate threshold freezes alone raise revenue in the region of the largest single tax measure of the decade. The actual cash impact on any individual depends heavily on their starting position and wage trajectory across the period. For a basic rate taxpayer on a typical salary, the cumulative impact has been modest. For a higher rate taxpayer on a steady pay growth trajectory, the cumulative impact has been substantial. For a director-shareholder navigating the £100,000 to £125,140 band, the effective marginal rate has remained at 60% throughout.
For National Insurance, the cumulative picture is more mixed. The main rate of Class 1 employee NIC has fallen from 12% to 8% over the period, partly offsetting the income tax fiscal drag for working-age earners. But the National Insurance secondary threshold drop to £5,000 from April 2025 and the employer rate increase to 15% have raised the cost of employment substantially, with much of the incidence falling on employees through wage moderation over time.
What we tell clients
The conversation our self assessment team has each year with higher earning clients now starts with the threshold position rather than with rates. The question "how do I stay below £100,000 of adjusted net income?" has become the most common question we are asked. Pension contributions and salary sacrifice remain the most powerful levers. Dividend timing and salary-dividend mix shift fractionally year-on-year as the optimal calculation changes.
For owner-managed business directors, the cumulative effect of fiscal drag across the period has been substantial — typically larger than any single Budget measure announced in the same window.
If you would like a multi-year fiscal drag analysis applied to your own position, contact our team.