500,000 more people pushed into 40% tax brackets – three ways higher earners are hit

The ongoing freeze in tax thresholds has dragged a further half a million people into higher tax brackets and the figure looks likely to get higher.

The government may have so far kept promises not to raise income tax rates but chancellor Rachel Reeves has continued the freeze on tax thresholds, which is pushing more people into paying higher rates as their earnings rise.

New projections from HMRC, suggests there are now 7.08 million higher rate income tax payers, a 38.7% increase compared with the 2022 to 2023 tax year.

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The number of additional rate income tax payers has also increased by 115.3% to 1.23 million, according to HMRC.

Most people are basic rate taxpayers, at 30.8 million, but this figure is only up 6.8%.

HMRC estimates that the average income tax liability across all income ranges is expected to increase by around £1,170, from £7,100 in 2022/2023 to £8,270 this tax year.

Rather than raising taxes, this has been achieved through stealth taxes in a process known as fiscal drag.

Source: HMRC.

What is fiscal drag?

Raising taxes is never a popular policy but the previous Tory government came up with a stealth way to collect more tax by freezing thresholds in 2022 until at least April 2028.

The Labour government has stuck with this policy, on top of raising capital gains tax and adding VAT to private school fees.

Previously, income tax thresholds rose with inflation but freezing them means workers can be quickly moved into higher tax brackets when they get a pay rise without the actual rate of tax rising.

Additionally, higher earners have been hit by falling capital gains and dividend allowances and a reduced personal savings allowance.

Research by AJ Bell shows receipts to HMRC are up £78 billion from these stealth taxes since 2022 and the taxman is expected to take a further £20 billion this year.

Laura Suter, director of personal finance at AJ Bell, said: “The deep freeze on income tax thresholds means the Treasury tax take continues to spiral.

“Last year’s general election saw Rachel Reeves repeatedly commit not to raise income tax on working people. While the government has stuck to the promise for now, the impact of the stealth tax first initiated by the previous government is still being felt by taxpayers."

While everyone from basic rate taxpayers to pensioners are hit by the frozen tax thresholds, Suter said it’s those who drift into higher tax bands as a consequence who feel the most pain.

Suter added: "Once you move over the £50,270 mark your next pound of earnings is hit with a 40p deduction, rather than the 20p paid by basic rate taxpayers, meaning you see much less of any salary increases in your payslip at the end of the month.

“Although the 45% additional rate tax bracket is theoretically only applicable to super high earners, there are now a whopping 1.23 million people paying tax on incomes above the additional rate threshold.”

Here is how higher earners are getting hit by the ongoing frozen tax thresholds.

Earnings

Average salaries may be rising but the frozen thresholds mean more people are becoming higher rate taxpayers.

HMRC took £228 billion from income tax in 2022/2023 and this is projected to increase to £298.6 billion – a 30% rise.

Rachael Griffin, tax and financial planning expert at Quilter, highlights that Labour has pledged to unfreeze thresholds in 2028, but warns that whether it can afford to follow through is another matter.

She said: “After four years of fiscal drag, the Treasury has become increasingly reliant on the quiet revenue boost these freezes deliver. Reversing that would come at a significant cost, particularly with pressure on public services and spending already high.”

Wealth taxes

It is not just salaries that are pushing people into higher tax brackets.

Dividend allowances have been cut over the past decade, from £10,000 in 2016 to £2,000 in 2019 and it is now just £500.

That affects anyone taking earnings as dividends from a limited company or if you are taking income from shares outside an ISA.

It has been good for the Treasury though, with HMRC data showing its dividend tax intake is set to increase by 26% to £18.6 billion.

That is before you even account for cuts to the capital gains allowance, which dropped from £12,300 to £6,000 in 2023 and is now at £3,000.

This means more of the profits from the sale of assets such as a second property will will go to HMRC.

We look at ways to cut your capital gains tax bill in a separate article.

Savings rates

Higher earners already get a lower tax-free personal savings allowance (PSA) of £500, but that means they have seen any benefits from putting money into the best savings accounts for high interest quickly disappear, as savings interest outside of the PSA is taxable.

This has helped HMRC triple its tax take from savings to £6.05billion.

With the Moneyfacts average savings rate currently at 3.53%, Adam French, consumer expert at Moneyfactscompare.co.uk said higher rate taxpayers with more than around £14,500 saved could expect to earn more than £500 in interest this tax year and could therefore find themselves footing an unexpected tax bill.

He said: “The latest statistics from HMRC show how important it is for savers to be aware of their tax liability. Especially many of those who have fallen into paying the higher-rate tax of 40%, who’s PSA has been halved from £1,000 to £500 as a result.”

How to reduce your tax bill

Taking a pay cut probably isn’t an option but you could keep your tax bill down by increasing your pension contributions through salary sacrifice.

It is important to make use of the dividend and capital gains tax-free allowances and plan how you take income and also make use of tax-free savings accounts such as an ISA.

French added: “Plenty of savers can avoid this tax bill by making use of their yearly ISA allowance, with cash ISAs keeping the savings of millions of people free from tax.

“They shouldn’t expect a raw deal either with some of the top paying easy access cash ISAs paying as much as 5% interest once introductory bonuses are taken into account.”