Fiscal drag is the stealthy way in which governments pull more and more taxpayers into higher tax brackets without the backlash that comes with increased tax rates. This is something taxpayers can probably live with when inflation is negligible, but it’s another matter entirely with inflation at over 11%.
Inheritance tax
One of the starkest examples of fiscal drag is the freezing of the inheritance tax (IHT) nil rate band that has been set at £325,000 since April 2009. Combined with soaring property prices, it is no surprise the government’s IHT receipts have nearly doubled in the ten years to 2021/22, with current year receipts set to see a further significant increase.
The nil rate band had previously been frozen at £325,000 until 2026, but the Autumn Statement has now extended the freeze until 2028.
IHT bills can sometimes be mitigated with careful lifetime planning, although people should be careful not to leave themselves short of funds later in life.
Income tax thresholds
The personal allowance (£12,570) and the basic rate tax threshold (£37,700) are unchanged since 2021/22, and, like the IHT nil rate band, are now set to remain frozen until 2028. Other thresholds are subject to fiscal drag because the government simply ignores them from year to year.
- The £100,000 income limit at which the personal allowance starts to be withdrawn is unchanged since withdrawal was introduced in 2010. Personal allowance withdrawal leads to a 60% marginal tax rate, and an estimated one million more taxpayers could be caught if nothing changes over the next five years.
- The High Income Child Benefit Charge income limit of £50,000 is unchanged since the charge was introduced in 2013. Around one in five families are now affected by the limit, compared to one in eight when the charge was first introduced.
To mitigate the impact of these frozen thresholds, some income tax planning may be possible for spouses and civil partners. Pension contributions can also reduce the amount of income counting towards the various income limits.
Details of income tax rates and personal allowances for the current tax year can be found here.
