What is fiscal drag? How you could protect your money from the taxman

Millions of taxpayers are set to pay more tax after chancellor Rachel Reeves announced the freeze on income tax thresholds will be extended until at least the 2030/31 tax year.

Frozen thresholds mean that as workers’ wages increase with inflation, they will be dragged into higher tax bands – a process called fiscal drag.

Income tax thresholds have been frozen since the 2022/23 tax year, after then-chancellor Rishi Sunak announced income tax brackets would not be adjusted yearly with inflation, as had been the norm, for four years.

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Another Tory chancellor, Jeremy Hunt, subsequently extended the freeze for a further two years until the 2027/28 tax year.

In the 2025 Autumn Budget, Labour chancellor Rachel Reeves extended the freeze on income tax thresholds until the 2030/31 tax year.

By the time the extended freeze ends, income tax bands will have been the same for almost a decade, meaning millions of UK taxpayers will have paid thousands more in income tax than if thresholds had increased in line with inflation.

We look at what ‘fiscal drag’ is, why successive governments have imposed it, and how much it is going to cost you.

What is fiscal drag?

Fiscal drag is simply the term used to describe what happens when a government does not adjust their income tax thresholds according to inflation and wage growth data.

This means that a higher number of taxpayers are dragged into paying tax for the first time, or at a higher rate, despite the purchasing power of their money not increasing at the same rate.

For example, in Autumn 2022 (when tax bands were first frozen), the tax-free personal allowance was £12,570.

According to the Bank of England’s inflation calculator, £12,570 in 2022 was worth around £14,403 in October 2025 when adjusting for inflation.

Normally, tax bands are adjusted for inflation, but, because they have been frozen, people today who earn the equivalent of £12,570 in 2022 (which is £14,403 in 2025) are now paying tax on the £1,833 difference that has occurred thanks to inflation.

Therefore, people are being dragged into paying tax despite not earning more money in real terms. Given the tax rate doesn’t rise, but the amount of tax raised increases, it is sometimes called a ‘stealth tax’.

How much will extended fiscal drag cost you by 2031?

With the freeze on income tax thresholds extended for an extra three years, taxpayers will be feeling the pain of fiscal drag even more profoundly – and higher earners will be bearing the brunt of the hit.

Taxpayers could be as much as £1,292 worse off thanks to the three year extension, research by AJ Bell suggests, compared to if the freeze ended in 2028 as planned.

But this will not be spread equally. Someone with a yearly income of £15,000 will only have to stomach an extra tax bill of £259 over the three year extension period.

Meanwhile someone on £47,000 will likely have to pay an extra £1,292 as their income is dragged into the higher rate of income tax.

How can you protect your money from fiscal drag?

While there aren’t many direct ways of avoiding fiscal drag apart from refusing to let your wages increase, there are some clever ways that you can mitigate its impact on your money.

First of all, it is important to get an idea of what your pay will look like for the year ahead so that you can plan accordingly.

“It’s always going to be difficult to predict whether you’re going to get a pay rise, and if so, how big it will be,” says Coles.

“However, it’s worth making an estimate and checking whether this will take you over a tax threshold into paying a higher rate of tax in the current tax year.”

Once you have established this, you can start to consider whether it is worth it for you to implement measures so that your income stays below the tax bracket you would otherwise enter.

This can be in the form of increased pension contributions or looking into salary sacrifice. Those who are set to breach tax thresholds may also want to utilise the tax wrapper that comes with a cash ISA or stocks and shares ISA.

Make the most of your ISA allowance

Using the ISA tax wrapper can “help stop your savings and investment income push you over a threshold,” says Coles.

This is because any growth that your money achieves in these accounts will not be taxed – especially as the tax rates on savings and investment income will rise from April 2026.

Esmund at interactive investor echoes this view, saying: “ISAs and SIPPs are great tools. To keep more of your money, a good strategy is to make the most of tax wrappers and to keep your portfolio costs low (keep an eye on fees).”

“Though few of us will be able to max out the allowance each year, prioritise using the most of this allowance before the allowance refreshes – even if you’ve not decided how to invest it, it’s worth making the contributions,” she continued.

The maximum you can save in an ISA in any given tax year is currently £20,000, but this is set to change in April 2027. The overall £20,000 limit will remain, but you will only be able to save a maximum of £12,000 in a cash ISA. This new rule won’t apply to over-65s.

Put more into your pension

A way to reduce your taxable income is by putting more of your salary away into your pension – this method “should not be underestimated”, according to Esmund.

This is because “unlike ISAs, you can roll over any unused allowance from the past three years and claim tax relief”. She added: “In fact, if you’re nervous about your tax bill – one option could be paying a bit more into your pension.”

Esmund notes that while this will leave you with less money in your pay packet at the end of each month, you will get upfront tax relief on your contributions – and you’ll still be able to enjoy the cash when you retire.

If you do this, “you’ll get an immediate 25 per cent boost in the form of a government top up and can claim back extra through self-assessment if you earn enough to pay 40 per cent or 45 per cent tax,” she said.

Consider salary sacrifice

Salary sacrifice offers another way for you to reduce your salary and therefore avoid the negative effects of fiscal drag.

Coles at Hargreaves Lansdown explains that “in some cases, the government will let you give up a portion of your salary, and spend it on certain things free of tax (and in some cases National Insurance).”

Salary sacrifice could be used to put more in your pension, get childcare vouchers, buy a bike through the bike-to-work schemes, and could be spent on other technology schemes.

“It won’t boost your take-home pay, but will cut your tax bill, and make your money go further, so it’s worth checking with your employer whether they offer this,” she added.

The amount you can salary sacrifice into a pension without having to pay National Insurance is set to change in April 2029 when a £2,000 per year cap will be introduced.

Plan your income

Another way to avoid the worst of fiscal drag is to carefully plan when your income enters your account.

Coles explains: “If there’s a time when you expect to be paying a lower rate of tax, consider whether you can take income then rather than now.”

For example, you could opt for a fixed term savings account that pays interest annually, instead of an easy access option which pays more frequently. You could then have the fixed savings interest pay out once you’re in a lower tax bracket.

“This often makes sense just before retirement,” according to Coles. “If this money is currently sitting in accounts paying interest in the current tax year, then from a tax perspective, the sooner you move them, the better.”