A pay rise should leave you with more money. But as earnings increase across the UK, some taxpayers are finding that a larger proportion of their income is also being taxed.

One reason is fiscal drag.

Fiscal drag occurs when tax thresholds remain unchanged while wages, pensions and other taxable income increase. More people can gradually start paying Income Tax, move into higher tax bands or lose part of their Personal Allowance even though headline tax rates have not increased.

The effect is particularly relevant in 2026 because the standard Personal Allowance remains £12,570 and the higher-rate threshold for someone with the standard Personal Allowance in England, Wales and Northern Ireland remains £50,270. The freeze of the Personal Allowance and basic-rate limit has also been extended through the 2030/31 tax year.

Understanding how fiscal drag works can help employees, pensioners, landlords and other taxpayers distinguish between a higher salary and the amount of additional income they actually keep.

What Is Fiscal Drag?

Fiscal drag describes the effect created when tax thresholds do not increase alongside earnings or inflation.

Imagine that someone’s salary rises over several years broadly in response to higher prices.

If tax thresholds increased at a similar rate, that person’s position within the tax system might remain relatively stable.

When thresholds are frozen, however, nominal income can continue increasing while the points at which tax becomes payable or higher rates apply remain unchanged.

As a result, a larger proportion of income can become taxable.

Someone who previously earned less than the Personal Allowance may begin paying Income Tax. A basic-rate taxpayer may move into the higher-rate band. Someone with adjusted net income above £100,000 may begin losing their Personal Allowance.

The Office for Budget Responsibility describes this process as fiscal drag and notes that frozen thresholds increase receipts as rising earnings bring more people into the tax system or higher tax rates.

UK Income Tax Thresholds for 2026/27

For the 2026/27 tax year, the standard Personal Allowance is £12,570.

For taxpayers in England, Wales and Northern Ireland with the standard Personal Allowance, the main position for relevant non-savings, non-dividend income can be illustrated as follows:

The table assumes the taxpayer is entitled to the full standard Personal Allowance. Individual circumstances can change the amount of allowance available.

Technically, HMRC defines the tax bands by taxable income after allowances. For 2026/27, the basic-rate band extends to £37,700 of taxable income, followed by the higher-rate band and then the additional-rate band.

This distinction becomes particularly important once adjusted net income exceeds £100,000 because the Personal Allowance begins to reduce.

A Note for Scottish Taxpayers

Scottish taxpayers have different Income Tax rates and bands for earnings, pensions and most other non-savings, non-dividend income.

For 2026/27, Scotland uses starter, basic, intermediate, higher, advanced and top rates ranging from 19% to 48%. Savings interest and dividends continue to be taxed under UK-wide rules.

The £50,270 higher-rate example used elsewhere in this article therefore applies primarily to taxpayers in England, Wales and Northern Ireland who receive the standard Personal Allowance.

Scottish taxpayers should use the applicable Scottish bands when assessing how increasing earnings affect their tax position.

How Frozen Thresholds Create Fiscal Drag

Consider an employee in England earning £49,000.

Assume that the employee is entitled to the standard Personal Allowance and has no other factors affecting the calculation.

At £49,000, their employment income remains below the £50,270 point at which income starts entering the higher-rate band.

Now suppose their salary rises to £53,000.

Their salary has increased by £4,000, but the higher-rate threshold has not moved with it. Part of their income now falls into the 40% band.

This is fiscal drag in practice.

The employee is earning more, but rising nominal earnings have moved some income across a tax threshold that remained fixed.

Over several years, the same process can affect progressively more taxpayers even if their pay rises largely reflect inflation rather than a substantial increase in real purchasing power.

Crossing a Tax Band Does Not Tax Your Whole Salary at the Higher Rate

One of the most important points to understand about UK Income Tax is that moving into a higher tax band does not normally mean your entire income is suddenly taxed at the higher rate.

Income Tax uses marginal bands.

Using the £53,000 salary example and assuming the standard Personal Allowance, only the relevant portion above the higher-rate threshold enters the 40% band.

Income falling within the basic-rate band continues to be taxed at the applicable basic rate.

This distinction matters when considering a promotion or pay rise.

Someone should not normally reject additional salary simply because part of the increase enters a higher Income Tax band. The correct question is how the additional income will be taxed and how much of it will remain after Income Tax and any other applicable deductions.

How Frozen Thresholds Increase Tax Receipts

Fiscal drag does not require the government to increase headline Income Tax rates.

Tax receipts can rise because wages and other taxable income increase while thresholds remain unchanged.

The Office for Budget Responsibility has explained that freezing thresholds rather than increasing them with inflation raises receipts as more workers enter the tax system or move onto higher rates.

The effect accumulates over time.

The OBR estimated in its November 2025 Economic and Fiscal Outlook that, had the Personal Allowance and higher-rate threshold instead increased with inflation, they would be approximately £4,900 and £20,100 higher respectively by 2030/31 than under the frozen-threshold policy.

These are forecast comparisons rather than alternative actual tax thresholds, but they illustrate the cumulative effect that several years of frozen thresholds can have.

The £100,000 Personal Allowance Taper

Fiscal drag becomes particularly significant when adjusted net income exceeds £100,000.

The standard Personal Allowance does not remain at £12,570 indefinitely.

HMRC reduces the Personal Allowance by £1 for every £2 of adjusted net income above £100,000. Once adjusted net income reaches £125,140, the standard Personal Allowance is normally reduced to zero.

For example, someone with adjusted net income of £110,000 is £10,000 above the £100,000 threshold.

Under the taper mechanism, their Personal Allowance would be reduced by £5,000, subject to their individual circumstances.

This means taxpayers approaching £100,000 need to consider more than the headline higher-rate percentage.

Additional income can both be taxable itself and reduce the amount of income protected by the Personal Allowance.

Why the Effective Marginal Income Tax Rate Can Reach 60%

The Personal Allowance taper creates an unusual result for taxpayers in England, Wales and Northern Ireland within the relevant income range.

Consider an additional £100 of income when someone is already above the £100,000 adjusted-net-income threshold.

That £100 can be subject to the 40% higher rate.

At the same time, because the Personal Allowance is reduced by £1 for every £2 of additional adjusted net income, another £50 of Personal Allowance can be lost.

That £50 can consequently become taxable at 40% as well.

In this simplified example:

• tax on the additional £100 is £40;
• tax arising from the £50 reduction in Personal Allowance is another £20.

The combined additional Income Tax is therefore £60 on £100 of additional income—an effective marginal Income Tax rate of 60%.

This is not a separate 60% statutory Income Tax band. It is the combined effect of the 40% higher rate and the gradual withdrawal of the Personal Allowance.

The calculation also does not represent every deduction or tax consequence that could apply to an individual’s circumstances.

What Is Adjusted Net Income?

The £100,000 Personal Allowance threshold is based on adjusted net income, not simply someone’s salary.

HMRC describes adjusted net income as total taxable income before Personal Allowances, adjusted for certain tax reliefs.

Depending on the individual, relevant taxable income can include:

• employment income and taxable employment benefits;
• self-employment profits;
• pensions;
• savings interest;
• dividends;
• rental income;
• certain taxable benefits; and
• foreign income where applicable.

Certain pension contributions and charitable donations made through Gift Aid can affect the adjusted-net-income calculation.

This is why someone earning a £95,000 salary should not automatically conclude that the £100,000 threshold is irrelevant.

Other taxable income could take adjusted net income above £100,000.

Conversely, qualifying pension contributions or Gift Aid may affect the final calculation.

Taxpayers approaching this threshold should therefore assess their overall circumstances rather than salary alone. Where several income sources or reliefs interact, professional personal tax services may help establish the relevant tax position.

How Fiscal Drag Can Affect Pensioners

Fiscal drag is not limited to employees.

Pensioners can also become liable to more Income Tax as pension income increases while the Personal Allowance remains frozen.

The State Pension is taxable income, although tax is not normally deducted directly from State Pension payments.

A pensioner’s overall taxable income might include a combination of:

• State Pension;
• workplace pension;
• private pension;
• employment income;
• savings interest; and
• property or other taxable income.

As these amounts increase, more pensioners can find that their total taxable income exceeds their available Personal Allowance.

The effect can be particularly important for someone receiving both State Pension and private or workplace pension income because the combined amount—not each income source considered separately—determines the wider Income Tax position.

Higher Pay Does Not Always Mean Equivalent Spending Power

Fiscal drag also matters because nominal income and real purchasing power are different concepts.

Suppose someone’s salary rises by 5%.

On paper, the employee earns 5% more.

But if prices have also risen substantially, much of the pay increase may simply compensate for higher living costs.

If tax thresholds remain frozen at the same time, a greater proportion of the employee’s nominal income may become taxable or move into a higher tax band.

The person should still generally have more gross income than before, but their after-tax increase in spending power can be considerably smaller than the headline pay rise suggests.

This helps explain why fiscal drag can affect people who do not necessarily consider themselves high earners.

Several years of ordinary salary increases can gradually move someone closer to a threshold that has remained unchanged.

What Can Taxpayers Do About Fiscal Drag?

Individual taxpayers cannot change national tax thresholds, but they can understand how their income interacts with them.

Start by considering total taxable income, rather than salary alone.

Depending on your circumstances, that might include employment income, pensions, rental profits, savings interest, dividends and other taxable income.

Then identify whether income is approaching an important threshold.

For example:

• Is income approaching the higher-rate band?
• Is adjusted net income approaching £100,000?
• Are several income sources interacting?
• Has rental or investment income increased?
• Could a bonus materially change the year’s tax position?
• Have pension contributions or Gift Aid donations affected adjusted net income?

The objective is not necessarily to avoid entering a higher tax band. Higher earnings can still leave a taxpayer financially better off.

The objective is to understand the marginal effect of additional income so that financial decisions are made using realistic after-tax figures.

Pension Contributions and Gift Aid

Pension contributions and Gift Aid can affect adjusted net income in certain circumstances.

This can become particularly relevant around the £100,000 Personal Allowance taper.

HMRC’s adjusted-net-income calculation takes account of qualifying pension contributions and grossed-up Gift Aid donations under the applicable rules.

However, tax should not be the only reason for making a financial decision.

A pension contribution moves money toward retirement and can restrict access to those funds. The appropriate amount depends on retirement objectives, cash requirements, pension rules and wider financial circumstances.

Similarly, Gift Aid should reflect a genuine charitable donation rather than being viewed simply as a tax-planning mechanism.

Tax efficiency should therefore be considered alongside liquidity, investment objectives and personal financial needs.

Why Fiscal Drag Matters Through 2031

Fiscal drag is likely to remain relevant beyond the current tax year.

The Finance Act 2026 extends the £12,570 Personal Allowance and £37,700 basic-rate limit through 2030/31. Together, those figures produce a £50,270 higher-rate threshold for someone entitled to the standard Personal Allowance.

If earnings continue rising during that period, more taxpayers can potentially cross frozen thresholds.

The effect will vary considerably between individuals.

Someone whose income remains unchanged may experience little or no threshold-driven change. Someone receiving regular salary increases, increasing pension income, growing rental profits or several taxable income streams may encounter the effects sooner.

That makes periodic tax reviews more useful than simply checking a tax band once and assuming the position will remain unchanged.

Questions to Review as Your Income Changes

When income increases, useful questions include:

• What is my total taxable income from all sources?
• Am I still entitled to the full Personal Allowance?
• Which tax bands apply where I live in the UK?
• How much of my next pay rise or bonus will enter a different tax band?
• Is my adjusted net income approaching or above £100,000?
• Do I receive rental, pension, savings or investment income in addition to salary?
• Are pension contributions or Gift Aid relevant to my adjusted net income?
• Do I need to budget for tax that is not automatically collected through PAYE?

For taxpayers with straightforward employment income, the answers may be relatively simple.

Where multiple sources of income, Self Assessment, property income, investments or the Personal Allowance taper are involved, the calculation can require more detailed consideration.

Final Thoughts

Fiscal drag is straightforward in principle but can have a significant cumulative effect.

When tax thresholds remain frozen while nominal incomes rise, more people can start paying Income Tax, move into higher tax bands or lose part of their Personal Allowance without headline Income Tax rates necessarily increasing.

For 2026/27, the standard Personal Allowance remains £12,570, while someone in England, Wales or Northern Ireland with the full standard allowance begins entering the higher-rate position above £50,270. Scottish taxpayers have a different rate-and-band structure.

The effect becomes particularly important around £100,000 of adjusted net income, where the Personal Allowance begins to taper.

With the major Personal Allowance and basic-rate-limit freeze extended through 2030/31, fiscal drag is likely to remain an important part of UK personal tax planning.

The practical lesson is not that earning more is undesirable. It is that gross income, taxable income and take-home income are different measures.

Understanding how they interact allows taxpayers to evaluate pay rises, bonuses, pensions and other income using what ultimately matters: how much additional income they actually retain.

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