Fiscal drag could cost high earners £4,000 by 2027

Frozen tax allowances are set to cost high earners with children the equivalent of £4,000, new research suggests.

The government froze personal tax thresholds in March 2021 in an effort by the Treasury to balance the state’s books but this has created a fiscal drag where people find themselves in higher than expected tax bands as wages rise.

New analysis from investment platform interactive investor reveals that the fiscal drag will cost the equivalent of £4,000 to higher earners with children by 2027.

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This is based on £1,967 paid in extra tax and £2,075 from lost child benefit.

WHAT IS FISCAL DRAG?

Before 2021, tax thresholds would rise with inflation.

That meant that if your wages rise, often you would still need to earn a lot more to be pushed into a higher tax band.

But personal tax thresholds were frozen by chancellor Jeremy Hunt until April 2028 during his 2022 Autumn Statement.

This increases the likelihood of being moved into a higher tax band when your wages rise, meaning more people end up being dragged into higher tax brackets without the actual rate increasing.

That is known as fiscal drag.

It is also reflected in other allowances such as the High-Income Child Benefit Charge.

Currently, if a parent or their spouse earns above £50,000, they need to pay a High-Income Child Benefit Charge of 1% for every extra £100 earned.

This threshold has remained the same since 2013.

The combination of frozen personal tax thresholds and the High-Income Child Benefit Chargeis hitting high earning parents, says interactive investor.

HOW FISCAL DRAG HITS YOUR FINANCES

Research by interactive investor has calculated how much higher, middle- and low-income earners are missing out on due to fiscal drag compared with if tax thresholds rose by inflation until 2027/28.

The calculations assume that wages rise with inflation between March 2023 and March 2027.

It found that high earners with £50,000 salary in 2022 are due to pay £1,967 extra tax by 2027 with frozen tax thresholds.

They are also affected by the High-Income Child Benefit Charge and will lost £2,075 of the payments.

A high earner with two children would also lose £2,075 in child benefit by 2027 due to the extra tax charge.

They would lose all their child benefit by 2027 as their salary rose with inflation, but the £50,000 tax threshold remains the same.

It isn’t just high earners who are affected though.

Low and middle earners with a £20,000 or £30,000 salary respectively will pay £889 extra tax by 2027 with frozen tax thresholds compared to if the thresholds rose with inflation.

“Fiscal drag is silent and ruthlessly efficient way of raising the tax burden over time,” says Alice Guy, head of pensions and savings at interactive investor.

“Frozen tax thresholds affect all of us, not just higher earners, because the frozen personal allowance means even lower earners gradually pay tax on more of their income.”

One the best ways to minimize your tax bill is to pay more into your pension.

“Pension payments receive tax relief, meaning you can claw back any income tax paid on your contributions as the taxman will pay tax relief straight into your pension,” adds Guy.

“This means it only costs £80 to pay £100 into your pension and £60 to pay in £100 for higher rate taxpayers.

“Some employers also offer salary sacrifice which means you can pay your salary directly into your pension, with no tax at all being charged. This is a great option, as you’ll save on national insurance as well as income tax, meaning it will only cost £68 to pay £100 into your pension for basic rate taxpayers and £58 to pay in £100 for higher rate taxpayers.”