720,000 people, or 65% of all those paying the UK’s highest rate of income tax are having to pay the 45% tax rate because of fiscal drag new research from Bowmore Financial Planning shows.
Fiscal drag occurs when the Government fails to increase the starting threshold for a tax in line with inflation. This inevitably leads to more and more taxpayers having to pay the top rate of tax. Many describe “fiscal drag” as a stealth tax.
The “additional rate” of tax was introduced as an emergency measure to help raise extra money following the global financial crisis. It was initially set at 50% and then reduced to 45% in 2013.
Had the starting point for the 45% tax kept pace with inflation since 2013, it would now stand at £211,562. Instead, the 45% tax rate is now payable on income over £125,140, meaning hundreds of thousands are paying the top rate who wouldn’t be if the band had moved with inflation.
If the top-rate threshold had moved with inflation to £211,562, only 385,000 taxpayers would currently fall within the top bracket — only 35% of those paying it today.
John Clamp, Fellow of the Personal Finance Society and Chartered Financial Planner at Bowmore Financial Planning, says: “Both the 45% and 40% rate of income tax are capturing more and more taxpayers.”
“A lot of people who consider themselves as having very little disposable income are now finding that they are having to pay the very highest rate of income tax.”
“Many see fiscal drag as a hidden stealth tax. The Government is content to let inflation do its work and add more and more people to the highest tax rate.”
“Many people are working harder but taking home less, simply because inflation has drawn them into higher tax bands.”
“When the 45% rate was introduced, it was meant for those on what were then the very highest salaries — the equivalent of over £210,000 today. Now, it’s hitting people earning almost £100,000 less than that.
“It’s perhaps unsurprising productivity is stagnating. If extra work barely boosts take-home pay because of frozen tax bands, people are less inclined to work longer hours or push themselves — and that ultimately drags on the economy.”
Frozen thresholds to drag more people into paying top rate of tax
John Clamp warns that still more people will be dragged into higher tax bands as income tax thresholds are frozen until 2028.
Clamp adds: “By keeping thresholds frozen despite inflation, the Government is effectively locking in annual tax rises without many taxpayers even realising. Leaving them unchanged for so long reduces public confidence in the tax system.”
“Those being dragged into the 45% tax bracket can lessen the impact of this effective tax rise by making pension contributions through salary sacrifice. This not only reduces taxable income but can result in tax savings of up to 60% on those contributions. It’s one of the few legitimate ways to offset the effects of fiscal drag.”
*HMRC data provided by FOI to Bowmore
