HMRC data released recently highlights the impact of the ‘fiscal drag’ phenomenon, with a significant rise in the number of individuals pushed into higher income tax brackets, including many pensioners facing taxation for the first time.
According to the latest statistics from HMRC, approximately 680,000 more individuals found themselves subject to the 40 per cent income tax rate in the 2022-23 tax year compared to the previous year, representing a substantial 15.3 per cent increase. Additionally, there was a 9.5 per cent uptick in the number of taxpayers subject to the 45 per cent additional rate.
Financial planning specialist Andy King from Evelyn Partners attributed this surge to fiscal drag, a consequence of inflationary salary increases leading more individuals to surpass tax allowances and thresholds that have remained frozen since April 2021. King emphasized that this trend is ongoing and will continue to escalate the tax burden until the freeze is lifted, which is not expected before 2028.
The freezing of personal allowances and other income tax thresholds can be perceived as a stealth tax hike, as rising inflation and wages diminish the real value of these thresholds, resulting in higher tax payments for individuals. Chancellor Rachel Reeves announced in her Autumn Statement on October 30, 2024, that she does not intend to extend the tax threshold freeze beyond 2028, dispelling speculations to the contrary. However, given the deteriorating state of public finances due to increased borrowing costs, this decision could be subject to revision in the future. Reeves is scheduled to provide an update on the country’s financial status on March 26.
HMRC data also reveals a 5.7 per cent increase in the number of taxpayers above pension age in the 2022-23 tax year compared to the previous year. With the state pension continuing to rise while the personal allowance remains stagnant, the disparity is expected to widen further. Tax and financial planning expert Shaun Moore from Quilter pointed out that the new state pension of £9,628 annually in 2022-23 accounted for over three-quarters of the £12,570 personal allowance. By 2025-26, the state pension is projected to reach £11,973 annually, almost equivalent to the personal allowance.
Moore highlighted that the continual increase in the state pension could lead to a substantial portion of pensioners being ensnared in tax obligations. The state pension benefits from the ‘triple lock’ policy, which guarantees annual increments based on the highest growth rate among average earnings, inflation, or 2.5 per cent. Should the state pension maintain an annual increase of at least 2.5 per cent, its value could surpass the personal allowance by 2027-28, necessitating pensioners to remit a portion of their pension income to HMRC.
As the fiscal landscape continues to evolve, individuals, particularly pensioners, are advised to stay abreast of tax implications and plan their finances accordingly to mitigate the impact of fiscal drag and changing tax policies.