Over the past five years, a significant 3.3 million more workers across the UK have been drawn into paying the higher rate of income tax. This substantial increase is a direct consequence of the government's decision to freeze income tax thresholds since 2021, meaning that as wages have risen, more individuals have crossed the unchanged thresholds into higher tax brackets.
This phenomenon, often referred to as 'fiscal drag', occurs when inflation and wage growth push individuals into higher tax bands without any proactive policy changes to tax thresholds. For many households, this has translated into a noticeable reduction in their disposable income, even as their gross earnings may have increased. The effect is particularly pronounced during periods of higher inflation, such as those experienced recently, where the purchasing power of earnings is already under pressure.
The current personal allowance, the amount an individual can earn before paying any income tax, and the higher-rate threshold have remained static since 2021. This means that individuals earning above a certain level are now seeing a larger proportion of their income taxed at 40%, rather than the basic rate of 20%. This effectively acts as a stealth tax, increasing the government's tax take without explicit rises in tax rates.
For UK businesses, the impact is multifaceted. While some might argue that reduced consumer spending power could dampen demand, the overall effect on the economy is a complex interplay. Businesses may face pressure from employees seeking higher wages to offset the increased tax burden, potentially impacting labour costs and profitability. The Bank of England's efforts to manage inflation are also intertwined with these fiscal policies, as reduced household spending could contribute to cooling demand, though at the cost of living standards.
The FTSE 100, while not directly impacted by individual tax thresholds, can reflect broader economic sentiment. A sustained squeeze on consumer spending power due to fiscal drag could eventually translate into weaker retail sales and slower economic growth, potentially affecting the revenues and profitability of UK-focused listed companies. Investors are advised to consider how these macro-economic shifts might influence their portfolios and to consult a qualified financial adviser for personalised guidance.