Why It Feels Like You're Paying More Tax – Understanding Fiscal Drag

At a Glance

Fiscal drag can increase the amount of tax people pay over time, due to freezing tax thresholds while incomes rise. This pushes more of peoples’ earnings into higher tax bands without changing tax rates. Fiscal drag can have long term financial consequences which can affect take-home pay in real terms whilst disproportionately affecting households across different income levels. It highlights how tax changes can affect household budgets and financial circumstances.

Fiscal Drag Explained

Many people notice that their tax bill seems to creep up over time, even when pay rises are modest. This effect is known as fiscal drag and it can result in people moving into higher tax bands without any official tax rise. 

It happens when tax thresholds stay frozen while wages increase over time due to inflation or cost-of-living pressures. As a result, a greater portion of income becomes taxable, and some people may move into higher bands, which can reduce take-home pay. 

When coupled with inflation, the effects of fiscal drag can be even more significant.

Understanding fiscal drag is important because it affects your take-home pay, savings plans, and long-term financial stability. As the 2025 budget changes come into effect, many people across the UK are likely to feel this squeeze, especially as allowances remain unchanged.

In this blog, we’ll discuss what fiscal drag is, why it happens, and how it impacts everyday taxpayers.

What is Fiscal Drag and Why Does It Happen

Fiscal drag occurs when tax thresholds stay the same, while wages gradually rise due to inflation or cost-of-living adjustments. This means that even if the government doesn’t increase tax rates, more of your income becomes taxable over time.

This can push people into higher tax bands or reduce the amount of their income that is covered by personal allowances. As a result, individuals can end up paying more tax over time, simply because the thresholds haven’t moved, not because they’re earning significantly more.

Fiscal drag often occurs during periods of frozen tax bands, which are currently planned to remain in place until 2031. This can increase the amount of tax revenue collected by the government, but can have the effect of reducing the real value of take-home pay.

How Frozen Tax Thresholds Reduce Take-Home Pay Over Time

When tax thresholds are frozen, they don’t rise in line with inflation or wage growth. This means that as your salary increases, more of your income becomes taxable and a bigger portion may fall into higher tax bands.

For example, most people in the UK are entitled to £12,570 tax-free personal allowance per year. As incomes rise, the tax-free personal allowance becomes a smaller percentage of overall income and taxable income becomes a larger proportion of overall earnings. While take-home pay may increase in cash terms, its real value may be reduced once inflation is considered.

In some cases, pay rises don’t go as far as expected, while a larger share of income ends up being taxed. Because this happens gradually and without any official tax rise, it’s easy to miss.

The result is a lower take-home pay compared to what you might expect, placing additional pressure on household finances even when headline tax rates haven’t changed. This gradual shift is the core effect of fiscal drag.

The Impact on Low, Middle & High Income Earners

Fiscal drag affects people at every income level, but in different ways. For instance:

Low-income earners may lose more of their tax-free allowance, meaning a larger share of their limited income becomes taxable.

Middle-income earners may experience a more noticeable impact, as small pay rises can push them into higher tax bands even though their real spending power hasn’t improved.

High-income earners may move deeper into the upper tax brackets or face reduced allowances, increasing their total tax bill.

In many cases, people across all different income levels may be affected and frozen thresholds can result in some individuals paying more tax over time without earning more in real terms, creating pressure on everyday budgets.

Long-Term Financial Consequences

Over time, fiscal drag may reduce the money UK households have available for savings, investment and everyday expenses. As more income becomes taxable, it may influence households’ ability to build emergency funds or contribute to pensions.

Small annual increases in tax add up, reducing overall resilience and potentially affecting longer-term financial outcomes, depending on individual circumstances. 

For many households, this can mean slower progress toward major goals like buying a home, paying off debt or planning for retirement.

Understanding the Role of Budgeting 

You can’t avoid fiscal drag entirely, but awareness and planning can help reduce its impact. Some people choose to review their budgets regularly to adjust for rising tax costs and protect their savings goals.

If you are looking to build savings for the future, you may want to learn more about the potential role of tax-advantaged accounts savings accounts such as ISAs or workplace pensions, which allow savings or investments without paying additional taxes. 

Finally, you may choose to check your payslip and tax code to ensure you’re not overpaying. These small, consistent steps can help individuals better understand their financial position as thresholds remain frozen.

Why Fiscal Drag Matters 

Fiscal drag matters because it can increase government tax revenue over time without changing tax rates, shaping how future budgets are planned.

As more people move into higher tax bands, the government aims to collect more money to fund public services, but households can feel a growing financial strain. 

This creates pressure for future policymakers to review frozen thresholds, adjust allowances or introduce reforms to ease the burden on taxpayers.

Understanding what fiscal drag is helps people see how tax policy affects them over time, not just today. It also highlights why updates to tax bands and allowances are an important part of maintaining fairness in the UK tax system.

For Financial Support in Difficult Times, Think Salad

Even with increases in the minimum wage on the way, fiscal drag and increasing costs of living can make managing finances more difficult than ever.

At Salad, we support employed UK residents access credit when they need it most, regardless of their credit score. 

That’s why we initially use an Open Banking-based assessment, instead of your credit score, to evaluate your current financial circumstances.

Applying for one of our new loans doesn’t impact your credit score. We use Open Banking in our initial assessment. If successful, we report your loan to the CRAs (Credit Reference Agencies). Your credit score is not used in our initial lending decision process and won’t hold you back from being eligible.