29th October 2026
Frozen personal allowances mean millions of taxpayers face rising bills even when the Chancellor announces no increase in income tax rates.
There was no increase in the personal allowance in this week's Budget. At first glance, that might sound like good news for taxpayers. The Chancellor has not raised the basic rate of income tax, and the amount people can earn before paying income tax remains £12,570.
But there is another side to the story. By leaving tax thresholds unchanged while wages, pensions and other incomes rise, the Government continues to collect more money through a process known as fiscal drag.
It is a tax increase that does not require the Chancellor to announce an increase in the tax rate.
How fiscal drag works
The personal allowance has remained at £12,570 since April 2021. The higher-rate threshold in England, Wales and Northern Ireland has also remained at £50,270, while the additional-rate threshold is £125,140.
These thresholds are due to remain frozen until April 2031 under existing policy.
Had the personal allowance and higher-rate threshold instead risen in line with inflation, the Office for Budget Responsibility estimated in November 2025 that they would be £4,900 and £20,100 higher respectively by 2030–31.
The consequences are straightforward. A worker receiving a pay rise may find that more of their income becomes taxable. Someone whose earnings cross a tax threshold may begin paying a higher rate on the portion above it. People whose incomes rise from below the personal allowance can be brought into the tax system for the first time.
The same principle affects pensioners whose state pension and private pension income together exceed the allowance.
The result is a growing tax burden even though the headline tax rates have not changed.
The billions involved
The OBR's November 2025 analysis estimated that income tax threshold freezes would raise an additional £56 billion a year by 2030–31 compared with a scenario in which the relevant thresholds had not been frozen. When the freeze on the employer National Insurance threshold was included, the total estimated annual effect reached £67 billion.
These are projected annual effects by the end of the forecast period, not the amount collected cumulatively over several years.
The October 2026 OBR report provides a fresh picture of the public finances. Income tax and National Insurance receipts are forecast to rise from £520 billion in 2026–27 to £610 billion in 2030–31. The OBR identifies frozen thresholds, combined with rising nominal earnings, as an important driver of this increase.
Not all of that additional revenue comes from fiscal drag. Earnings growth, changes in employment, other tax measures and wider economic developments also affect receipts. Nevertheless, the freeze is a substantial part of the explanation.
Inflation makes the problem worse
The latest OBR forecast also highlights why fiscal drag can become more severe when inflation rises.
Higher prices put pressure on households, which may receive pay rises to compensate. But if the tax thresholds do not move, a greater share of those higher earnings can be taxed.
The OBR estimates that, under the current policy of frozen thresholds, a one-percentage-point increase in nominal earnings and CPI inflation would raise income tax and National Insurance receipts by an average of £7 billion a year. That is around £2.5 billion more each year than if the thresholds were rising with inflation.
This is a measure of the additional sensitivity of tax receipts to changing earnings and prices, not the total revenue from the freeze.
The latest outlook expects inflation to rise sharply in 2027 before returning towards the 2 per cent target in 2028, assuming energy prices subsequently decline as markets anticipate. If inflation proves more persistent, the pressure on household budgets and tax receipts could be greater.
Pensioners are not necessarily protected
The effects are not confined to workers.
The full new state pension is already close to the personal allowance and is projected to exceed it from 2027–28. Pensioners with private pensions, savings income or other taxable income can therefore face growing tax bills as their total income rises.
The Government has announced a pension tax allowance intended to remove the administrative burden of paying small amounts of tax through Simple Assessment for people whose only income is the basic or new state pension. That is a targeted measure, however, rather than a general increase in the personal allowance.
Pensioners with additional income can still be affected by fiscal drag. The distinction matters because two people receiving the same state pension may have very different tax positions depending on their other income.
The economic consequences
The OBR has also estimated that the income tax and National Insurance threshold freezes between 2022–23 and 2030–31 could reduce labour supply by the equivalent of 215,000 people working average hours by 2030–31.
This does not mean that 215,000 people will necessarily lose their jobs. It is an estimate of the combined effect on the amount of labour supplied, expressed in full-time-equivalent terms.
The concern is that when more of an extra pound earned is lost to tax, some people may decide that additional hours or a better-paid job are less worthwhile.
For businesses already struggling with higher employment costs, weaker consumer spending and uncertainty about the economy, the wider consequences deserve attention.
A difficult choice for the Chancellor
There is a legitimate argument for retaining the freeze. The Government faces high borrowing costs, substantial public spending commitments and pressure to improve the public finances. Raising tax thresholds in line with inflation would reduce the revenue expected from the current policy and require some combination of higher borrowing, spending reductions or other tax increases.
But the freeze also raises a question of transparency.
Taxpayers are accustomed to hearing about changes to tax rates in Budget speeches. Fiscal drag is less visible, even though its effect on household finances can be substantial over time.
A person can be paying more tax without receiving a real improvement in living standards. A pensioner can cross the tax threshold even when an increase in pension income merely compensates for rising prices. A worker can receive a pay rise yet find that the extra money goes less far than expected.
The Budget may contain reliefs intended to help particular households, but these need to be considered alongside the continuing effect of frozen thresholds.
The Chancellor has not raised the personal allowance this year. That does not mean the tax burden is standing still.
Fiscal drag has become a major source of additional tax revenue. The question is whether taxpayers should be given a clearer account of how much they are paying through this mechanism, and whether the policy can continue indefinitely without a more open debate about who bears the cost.
Sources
Office for Budget Responsibility, Economic and Fiscal Outlook – October 2026.
Office for Budget Responsibility, Implications of personal tax threshold freezes, November 2025.
House of Commons Library, Fiscal drag: An explainer, April 2026.