A report in the Guardian makes for sombre reading. It reveals a report by the Organisation for Economic Cooperation and Development (OECD), which found that taxes on British workers rose at the fastest rate in 2025, when compared to the World’s richest nations.
The revelation may not surprise many readers, as millions of households across the UK have had to deal with increased tax liabilities in recent years. What you may not have realised though, is when it comes to Income Tax, your exposure to it could have increased significantly even though the rates haven’t risen.
The reason for this is a lesser-known financial phenomenon called ‘fiscal drag’. If you want to discover more about fiscal drag, how it could impact you and how you may be able to mitigate its effects, read on.
Successive Governments have frozen the Income Tax thresholds
While it may feel as though the Government taxes every penny that you have, in reality it provides a range of allowances and thresholds to help reduce your liability. While you might assume these allowances and thresholds increase in line with the rising cost of living, which is also known as inflation, this isn’t usually the case.
This is why the Government was able to freeze the Income Tax thresholds in 2022/23, and then again in 2024, when former Chancellor, Rachel Reeves, extended the freeze to 2031. If the freeze does remain in place up until then, the thresholds will have remained static for nine years.
As a result of this, millions of British workers have seen a significant increase in the amount of Income Tax they pay. Let’s look at why this is next.
What might the threshold freeze mean for me?
Employers typically increase salaries every year to help employees cover the rising cost of living, otherwise known as inflation. As such, when inflation is higher, as it’s tended to be in recent years, employers typically provide greater salary increases to offset the higher cost of goods and services.
However, because the Income Tax thresholds have remained the same while salaries increased, many workers have been pushed up into a higher tax band. This means their Income Tax liability could have increased substantially.
According to Which?, since the threshold freeze began in 2022/23, more than 1.7 million workers are paying Income Tax for the first time or have been pushed up into a higher tax band.
What are the Income Tax thresholds in 2026/27?
In 2026/27, the amount you can earn before Income Tax is charged, which is known as the Personal Allowance, is £12,570. Any taxable income received between £12,571 and £50,270 is taxed at 20%, also known as the basic rate. If you earn between £50,270 and £125,140, which is the higher-rate tax bracket, the portion of your taxable earnings that fall into this range is liable to Income Tax at 40%.
If you earn more than £125,140, the part of your salary that breaches this threshold will be liable to additional rate tax, which is charged at 45%.
Can I mitigate the effects of fiscal drag?
There is some good news, as there are steps you can take that could help to mitigate the effects of fiscal drag. One way could be to increase the level of contributions that you make to your pension, as HM Revenue and Customs typically refunds the Income Tax you’ve paid on the money you use to make contributions.
That said, the level of contributions that receive tax relief is limited to your Annual Allowance, which is capped at £60,000, or 100% of your relevant UK earnings, whichever is the lower amount. With this in mind, if you are considering boosting your pension you should talk to a financial adviser to ensure it’s appropriate for you and is your best option.
Should I consider using salary sacrifice?
While it will depend on your individual circumstances, using salary sacrifice to reduce the effects of fiscal drag on your earnings could be a shrewd idea. Otherwise known as 'salary exchange', this is where you and your employer agree to reduce your salary and put the difference towards an agreed benefit.
This could be, for example, an increased payment into your workplace pension or an employer provided childcare scheme. By swapping some of your income for the benefit, you’re effectively taking a reduction in salary, which could help to reduce your Income Tax liability.
In addition to this, it will lower the amount of National Insurance Contributions (NICs) you pay, which could also help to mitigate fiscal drag.
Could salary sacrifice drop me down into a lower tax-band?
If your pay rises have pushed you over the threshold into a higher tax bracket, you might be able to use salary sacrifice to drop back down into the lower band. This could reduce your exposure to Income Tax while potentially boosting your standard of living in retirement, if you put the sacrificed salary into a pension.
While this may, on the face of it, sound like a good idea, salary sacrifice shouldn’t be entered into lightly as it’s not suitable for everyone. For example, it could reduce your Death in Service benefit and may make it more challenging to obtain the level of mortgage borrowing you might want.
This is why you should always speak to a financial adviser before going ahead, so that you understand the pros and cons of opting for it. Please remember that, as from April 2029, the NICs relief offered by salary sacrifice on workplace pension contributions will be capped at £2,000 a tax year. After this, NICs will be charged at your usual rate.
Can AFH Wealth Management help?
As one of the UK’s largest truly independent financial advice companies, we can help you understand the impact of fiscal drag on your earnings and wider wealth. Additionally, we can help you to understand how you may be able to mitigate its effects on your earnings and wider wealth.
If you would like to speak to one of our Independent Financial Advisers, please call us on 0333 010 0008. We would be happy to arrange a no obligation initial meeting with one of our independent financial advisers.
17 July 2026