What Is "Fiscal Drag" and Why It Matters in Scotland - Even Worse After Latest Budget

14th January 2026

Fiscal drag occurs when tax thresholds (the income levels at which different tax rates apply) stay frozen while wages rise in nominal terms.

As people's pay increases with inflation or wage growth, more of their income becomes subject to tax or taxed at higher rates without any change in tax rates themselves. That effectively increases the average tax paid, even if the government hasn't formally raised rates.

In Scotland's case, income tax bands for the higher, advanced, and top rate were frozen at their current levels for future years in the recent budget, even as lower-rate bands were lifted marginally. This means that as people’s nominal wages rise, more workers get "pulled into" higher tax brackets — contributing more tax — because they cross thresholds that haven’t kept pace with inflation.

UK-wide fiscal drag from frozen thresholds has been described as a "hidden tax increase" because wage growth pushes people up into higher tax bands automatically.

How It’s Hitting Scottish Taxpayers After the Budget

More People Are Being Moved Into Higher Tax Bands

The proportion of Scottish taxpayers paying a higher rate of income tax has been rising — partly because thresholds haven’t kept pace with wage growth. Between 2022-23 and 2023-24, the share of Scottish taxpayers in the higher-rate band rose from 17.3% to 19.2%.

This is a clear sign of fiscal drag: people aren’t necessarily earning more in real terms, but they are earning more in nominal terms, enough to push them into higher tax brackets with no change in their real living standards.

Because Scotland’s tax system has more bands and a lower higher-rate threshold than the rest of the UK, fiscal drag can be more pronounced here than in England or Wales.

The Recent Budget Only Slightly Eases Fiscal Drag for Lower Earners

While the Scottish Government raised the starter and basic rate thresholds — which does give some relief to lower-income workers — this adjustment is very modest relative to inflation and nominal wage growth. Independent analysis suggests the maximum saving from those changes is tiny (well below £15 in some cases).

Meanwhile, thresholds for higher rate bands were left frozen in cash terms. That means fiscal drag will continue to push people into higher tax bands over time, increasing their tax bills even as the headline rates stay the same.

Why Tax Receipts May Be Growing More Slowly (or "Dropping" Relative to Expectations)

It’s important to separate tax receipts rising from tax receipts rising as much as forecast:

Structural Tax Growth Versus Forecast Changes

According to the latest forecasts from fiscal authorities, Scotland’s net tax revenue contribution (after adjusting for block grant adjustments and other technical factors) is expected to be lower in 2025-26 than earlier forecasts — mainly because the relative growth in Scottish income tax bases is weaker than assumed in previous projections. That reduces the net benefit to the Scottish Budget compared to what was forecast earlier.

In simple terms: tax receipts may still be rising year-on-year, but they aren’t rising as much as projected, so the budgetary impact is less positive than expected.

Broader Economic Context and Growth Challenges

Another influence on tax receipts is the performance of the economy itself. Audit Scotland and other analysts have pointed out that slower earnings and employment growth in Scotland relative to the rest of the UK reduces the impact of devolved taxes on the Scottish budget. That means tax bases are not expanding as quickly as hoped, dampening revenue growth.

Putting It Together - The Effect on Scottish Taxpayers

Fiscal drag continues to raise the effective tax burden for many Scots because:

Thresholds for higher tax bands are frozen, so wage inflation means more income is taxed at higher rates over time.

Modest increases in lower-rate thresholds do little to offset the upward pressure on taxable income for middle-income earners.

As a result, many workers will find themselves paying more tax year-on-year even without any formal rate increases.

At the same time, tax receipts may be underperforming relative to earlier forecasts, not necessarily because they are falling in cash terms, but because underlying economic growth and the tax base in Scotland are growing more slowly than assumed — limiting the boost to public finances.

Fiscal drag is still a real and ongoing factor in Scotland’s tax system

It increases the amount of income tax paid by many individuals simply because of nominal wage growth and frozen thresholds.

The recent Scottish Budget does little to reverse this trend for most taxpayers, offering only modest relief at the lowest rates while leaving higher and additional rate thresholds unchanged.

Tax receipts may appear “weaker” against forecasts not because collections are falling, but because the Scottish tax base is not growing as fast as previously projected, partly due to economic performance.