Stagnant tax thresholds from the 1980s - projected updates by present day
In the UK, a long-standing trend of adjusting tax thresholds in line with inflation to prevent taxpayers from being pushed into higher tax brackets due to nominal income growth has been disrupted in recent years. This shift has resulted in a significant increase in the tax burden for many UK taxpayers.
Since 2021, the Income Tax higher-rate threshold has remained frozen at £50,270, a level that, if adjusted for inflation, would be around £62,000 today. The additional rate threshold, the point at which the additional rate of tax kicks in, has been frozen at £125,140 since April 2010, a figure that, in today's terms, should be approximately £231,000.
The 60% income tax trap, which occurs when income exceeds £100,000, has also been affected by these frozen thresholds. Inflation has effectively moved the £100,000 tax threshold for the 60% tax trap from £100,000 to just over £150,000.
Moreover, the Capital Gains Tax exemption, which peaked at £12,300 in 2020/21, has been reduced back down to £3,000 as of April 2023, a level not seen since 1981.
The Office for Budget Responsibility predicts that by 2028/29, 3.5 million more individuals will be pulled into the higher-rate tax band of 40%. Meanwhile, the nil-rate inheritance tax band has been frozen at £325,000 since 2009, a core reason why inheritance tax receipts are increasing year on year.
The residence nil rate band, which increases the tax-free threshold for many homeowners, has not budged for five years. Any basic-rate taxpayer who moves up to the higher-rate tax bracket at 40% will see their personal savings allowance (PSA) halved, from £1,000 worth of savings interest tax-free each year to just £500.
Unless you leave your family home to direct descendants, such as children and grandchildren, you don't qualify for the residence nil rate band. The Inheritance Tax annual gifting allowance has been frozen at £3,000 since 1981, while if adjusted by inflation, it should be £11,529 today.
The income tax threshold freeze is set to continue until 2028/29. The difference between the current Inheritance Tax annual gifting allowance and its inflation-adjusted value is £8,529. The Dividend Allowance, the amount you can earn in dividends every year tax-free, has been reduced from £5,000 in 2016 to its current level of £500.
If the Dividend Allowance had risen with inflation instead of facing cuts, it would be £6,876 today. The Inheritance Tax nil rate band, the amount that can be passed on tax-free, has been frozen at £325,000 since April 2009. If adjusted by inflation, it should be £517,007 today.
Chancellor Rachel Reeves has stated that extending the freeze until 2030 would boost government coffers by billions of pounds, but has also noted that it would hurt working people and go against Labour's manifesto commitments.
This trend of freezing or slowing the growth of tax thresholds relative to inflation rates, often referred to as "fiscal drag," pushes more taxpayers into higher brackets even if their real incomes do not grow. This has become a contentious issue in the UK, with many arguing that it disproportionately affects lower and middle-income earners.
- The Dividend Allowance, once at £5,000 in 2016, is now only £500, if it had risen with inflation, it would be £6,876 today, reflecting a significant decrease in personal finance benefits for business owners.
- In the realm of personal-finance, the Inheritance Tax nil rate band, originally £517,007 if adjusted by inflation, remains frozen at £325,000 since April 2009, leading to an increased tax burden for pensioners and savers.
- The additional rate threshold for income tax, which should be around £231,000 if adjusted for inflation, has been frozen at £125,140 since April 2010, potentially pushing more UK taxpayers into the 40% higher-rate tax bracket, impacting their personal savings and overall personal finance situation.
