City thinking, local knowledge

Pay More, Get Less: How Fiscal Drag is Eroding Your Income

By Questa Chartered

How closely are you watching your tax allowances? With election campaigning ramping up, we’ll hear plenty about potential tax cuts. However, the latest data from HMRC paints a stark picture. From April 2023 to March 2024, HMRC’s total revenues from tax receipts and National Insurance Contributions hit a staggering £827.7 billion, marking a £39.1 billion increase from the previous year. Let’s take a look at the influence of fiscal drag.

Since the Conservatives came into power in 2010, this figure has surged by an eye-watering 83%. For context, inflation over the same period only rose by 49%. If tax revenues had merely kept pace with inflation, taxpayers would have paid £674 billion instead of £827.7 billion—a whopping £153.7 billion less than what was actually collected last year.

Feeling the Pinch? You’re Not Alone

It’s easy to blame the COVID-19 pandemic for this spike, but the numbers tell a different story. Between 2019/20 and 2023/24, tax revenues jumped from £633 billion to £827 billion—a 31% increase compared to an inflationary equivalent of 23%. While still above inflation, this is somewhat better than the 14-year trend.

A significant driver of this increase is fiscal drag. When personal income tax allowances remain static, more people find themselves paying taxes or moving into higher tax brackets. It’s expected that around 2.5 million more people will be paying taxes in 2024, adding strain to HMRC’s already overloaded helpdesk services.

Since 2021, personal income tax allowances and thresholds have been frozen. Jeremy Hunt announced plans to continue this freeze until 2028. Normally, these thresholds would rise with the Consumer Price Index (CPI). The personal allowance and higher rate thresholds have been £12,570 and £37,700 since 2021. If adjusted for CPI, they should have been £15,225 and £60,886 for 2024-25. For someone earning £50,000, this means paying an extra £13,000 in taxes over the duration of the freeze.

While the personal allowance was just £6,475 in 2010/11, today’s £12,570 is still a reasonable increase in real terms. However, the freeze has undoubtedly exacerbated the tax burden on many.

Politicians and Pensions: The Triple Lock Dilemma

As we approach the next election, expect to hear more about tax thresholds. It’s not an issue unique to the current government, and Labour has yet to provide concrete plans on addressing it.

Prime Minister Rishi Sunak has pledged to keep the state pension tax-free if re-elected, but this offers little relief for those below state pension age and provides minimal tax savings for retirees with substantial incomes. The triple lock pension, which has significantly increased state pension earnings, is a double-edged sword. While it’s a popular policy among pensioners, it also contributes to more retirees paying taxes.

Both major parties face a balancing act. The triple lock’s generosity has boosted pensions beyond original expectations, making it a significant factor in the increasing number of retirees facing taxes. However, neither party dares to remove such a popular policy.

Maximising Your Tax Allowances: Practical Steps

In light of these trends, it’s crucial to maximise every tax allowance available. Here are some practical steps to ensure you’re not paying more than necessary:

  1. Use Your ISA Allowance: Individual Savings Accounts (ISAs) are a tax-efficient way to save and invest. For the 2023/24 tax year, you can invest up to £20,000 into ISAs. This can be a combination of Cash ISAs, Stocks and Shares ISAs, or Innovative Finance ISAs.
  2. Consider Lifetime ISAs: If you’re aged 18-39, Lifetime ISAs (LISAs) allow you to save up to £4,000 per year with a 25% government bonus, aimed at first-time home buyers or retirement savings.
  3. Take Advantage of Pension Contributions: Contributing to your pension is a highly tax-efficient way to save for retirement. The government provides tax relief on contributions, boosting your pension pot. Ensure you’re making the most of employer contributions as well.
  4. Junior ISAs for Children’s Savings: For those with children, Junior ISAs (JISAs) offer a tax-free way to save for their future. You can contribute up to £9,000 per year, and the money grows tax-free.
  5. Plan for Capital Gains: Utilise your annual capital gains tax allowance. For the 2023/24 tax year, the allowance is £3,000. By planning the sale of assets, you can minimise the capital gains tax liability.
  6. Explore Enterprise Investment Schemes (EIS): EIS offers significant tax reliefs to investors in smaller, high-risk companies. These include income tax relief, capital gains deferral relief, and exemption from capital gains tax on EIS shares held for more than three years.

Keeping Ahead of Tax Changes

The tax landscape is ever-changing, influenced by political shifts and economic conditions. Staying informed and proactive about your tax planning can make a substantial difference to your financial health.

Regularly reviewing your financial situation with a qualified adviser ensures you’re making the most of available allowances and reliefs. This proactive approach not only mitigates the impact of fiscal drag but also optimises your overall tax position.

Final Thoughts on Fiscal Drag

While the increasing tax burden can feel overwhelming, strategic planning and taking full advantage of tax allowances can help ease the strain. Whether it’s through ISAs, pension contributions, or other tax-efficient investments, making informed decisions now can significantly benefit your financial future.

Latest News

July Market Commentary

June 2024 was a significant month for global financial markets, marked by notable volatility and key economic developments. The interplay of geopolitical tensions, economic data releases, and central…

Pensions and Politics: What You Need to Know

Pensions have long been a focal point in UK politics and, perhaps even more so after an election, the spotlight on retirement savings has never been brighter. Pensions…

The Implications of the King’s Speech on Your Finances

The recent UK King’s Speech delivered by King Charles III on 17th July 2024, has set a clear path for the government’s legislative agenda. These new policies and…