Autumn Budget 2026: The hidden cost of frozen tax thresholds

With the Budget approaching, the annual guessing game is getting going. What will go up? What might disappear? And should we all be doing something before the Chancellor stands up?

But while everyone watches for the next tax rise, some are already happening. Quietly. Without anyone needing to change a headline rate.

Leave a tax threshold alone for long enough and inflation does the heavy lifting. Your salary rises, your business puts its prices up, your house increases in value. The thresholds stay put.

You might not feel any wealthier. HMRC, however, would like a word.

How frozen tax thresholds increase what you pay

Economists call this “fiscal drag”. Most of us would probably call it paying more tax.

If your pay rises just enough to cover higher living costs, you are broadly standing still before tax. But with a frozen personal allowance, more of your income becomes taxable. Cross another frozen threshold and some of it may face a higher rate too.

Very convenient. For the Treasury, anyway.

Several of these thresholds were actually designed to increase with inflation. The personal allowance, basic-rate income tax limit and inheritance tax bands have statutory uprating provisions. Governments have repeatedly overridden those increases. VAT is slightly different: inflation increases were the normal policy assumption, rather than an automatic legal requirement.

So how much ground have they lost?

The figures below show what the starting amounts would be worth if they had kept pace with CPI to July 2026. They illustrate the loss of purchasing power, rather than reproduce the precise statutory increases: uprating dates, rounding rules and inflation measures differ. VAT’s usual benchmark was RPI. Calculations use ONS inflation data.

*The higher-rate threshold shown applies to earnings in England, Wales and Northern Ireland. Scotland has different bands.

**The £2 million taper threshold was initially fixed. April 2020 is used here because annual inflation increases were due to begin in 2021/22.

Take the personal allowance. It has sat at £12,570 since April 2021, with the freeze now running through 2030/31. The £50,270 higher-rate threshold is frozen too. The latter combines the personal allowance and basic-rate limit, both normally subject to inflation increases.

A pay rise can therefore move someone into higher-rate tax without delivering anything like the improvement in lifestyle that “higher earner” might suggest.

Let’s put some numbers on it. Someone earning £40,000 when the thresholds were frozen in 2021 would have paid £5,486 in income tax. With pay rises broadly matching CPI, they would now earn around £52,000, with much the same purchasing power. Had the allowances and thresholds kept pace too, their income tax bill would be roughly £7,100. Instead, it is around £8,200. That is approximately £1,100 more tax a year because the thresholds stood still. Same standard of living before tax. A rather different story afterwards.

Even if you remain a basic-rate taxpayer, the freeze still bites. The inflation-adjusted personal allowance in the table is roughly £3,700 higher than the actual allowance. For someone paying 20% tax across that difference, that represents around £740 a year.

Quite a lot for something that supposedly hasn’t changed.

Why the VAT threshold can hold back business growth

VAT brings a different problem.

To be fair, the registration threshold increased from £85,000 to £90,000 in April 2024. But that followed seven years at £85,000. Some breathing room, certainly. Catching up with inflation? Hardly.

A business can be doing exactly the same amount of work, raising prices merely to cover higher costs, and still find itself needing to register.

For businesses whose customers cannot reclaim VAT, that can mean increasing prices again or absorbing the VAT and accepting a smaller margin. Recovering VAT on eligible costs may help, but it does not necessarily make the sums work.

You can see why an owner approaching the threshold might hesitate before taking on more work. An odd incentive in an economy that wants businesses to grow.

Why the VAT threshold can hold back business growth.

How frozen Inheritance Tax (IHT) thresholds affect estates

And then we come to IHT.

The main nil-rate band has been £325,000 since April 2009. Seventeen years. There are people learning to drive who were not born when that figure was last increased.

Keeping pace with CPI over that period would put it at around £540,000. Instead, rising asset values leave more of an estate exposed to tax above the same old allowance.

The residence nil-rate band adds up to £175,000 where a qualifying home passes to direct descendants. But it shrinks once an estate exceeds £2 million. Both were due to receive annual CPI increases from 2021/22. Those increases were switched off, and all three IHT thresholds are now fixed through 2030/31.

Rising estate values can therefore expose more assets to tax while taking away part of an available allowance. A fairly unpleasant double act.

What you can do about frozen tax thresholds

The practical response starts with checking where you sit. Look at what a pay rise will actually leave you with. Monitor business turnover and model VAT before registration becomes compulsory. Revisit estate values, wills and available allowances rather than assuming an old calculation still holds.

And, as ever, don’t let the tax tail wag the dog. Turning down profitable work or giving away money you still need is hardly a victory.

When the Budget arrives, pay attention to what stays frozen as well as what changes.

The Chancellor doesn’t need to put your tax rate up to help themselves to more of your money.