What Is Fiscal Drag And Why Is It Costing You More Tax Every Year?

Fiscal drag is when tax brackets are “frozen,” which results in people paying more tax even though tax rates don’t actually change.

(It essentially “drags” people into a higher tax bracket. )

The impact of fiscal drag depends on three core factors:

• Tax thresholds: the earnings at which different tax rates kick in
• Inflation: how much the cost of goods and services rise
• Wage growth: an increase in the amount of earnings you receive

Fiscal drag is sometimes called a “stealth tax” as it allows the government to increase the amount of money collected from taxes without directly increasing tax rates.

Fiscal drag can significantly impact the economy as it could impact a person’s spending power.

When people have less disposable income, they often cut back on expenses, which can slow down economic growth.

Sometimes, fiscal drag can be used to help manage the economy if it’s growing too quickly by reducing how much people spend.

Fiscal drag usually happens subtly but the impact can drastically affect your finances. Some of the ways you can help to reduce the impact of it include:

• Understand the rules: try to keep up-to-date with changes to tax thresholds and understand what tax you might need to pay
• Maximise your allowances: take advantage of all the tax allowances and tax reliefs available including pension contributions and ISA allowances to minimise your taxable income
• Get strategic with income: consider ways to manage growth in your income including taking our salary as income compared to using dividends and what tax allowances you can use
• Speak with a specialist: tax can be complicated so it might be worth speaking with a tax specialist or financial adviser to get tailored help