Hidden fiscal drags for taxpayers to be aware of in UK

10th November 2025

The primary "hidden fiscal drag" taxpayers should be aware of is fiscal drag (or "bracket creep"), which occurs when inflation and wage growth push people into higher tax brackets or reduce the real value of tax allowances and thresholds that are not increased in line with prices.

This effectively increases the tax burden without the government explicitly raising tax rates.

Key hidden fiscal drags include:

Frozen Income Tax Thresholds
The most significant fiscal drag is the freezing of income tax personal allowances and higher-rate thresholds. As wages rise due to inflation, a larger portion of income becomes taxable or is taxed at a higher rate (e.g., being dragged into the 40% higher rate band), even if the taxpayer's purchasing power (real income) has not increased.

Reduced Allowances for Higher Earners
Earning above certain thresholds can trigger the reduction or removal of other allowances. For instance, the Personal Allowance starts to decrease by £1 for every £2 earned over £100,000, creating an effective marginal tax rate of 60% within that income band.

Frozen Pension Allowances
With state and private pensions often rising with inflation, frozen personal allowances mean more pensioners are being pulled into paying income tax for the first time.

Tax on Savings Interest
As interest rates have risen, more people find themselves earning interest above the Personal Savings Allowance (£1,000 for basic-rate taxpayers, £500 for higher-rate, and zero for additional-rate) and must pay tax on their savings interest, a problem that was less common with historical low interest rates.

Inheritance Tax (IHT) Thresholds The main IHT nil-rate band has been frozen at £325,000 since 2009. With property and asset values increasing over time, more estates are caught by IHT liabilities, even those with relatively modest assets.

Dividend Allowance Reductions
The amount of tax-free dividend income has been reduced in recent years, meaning investors may face higher tax bills on their investments.

Indirect Taxes (e.g., VAT and Insurance Premium Tax)
These are often hidden as they are included in the price of goods and services. As prices rise with inflation, the absolute amount of tax collected increases, often without the consumer's explicit notice.

Taxpayers can mitigate the impact through strategies such as maximising contributions to ISAs and pensions, which are tax-efficient wrappers.