Had a pay rise? You’re already £600 a month worse off

When the Chancellor delivers the Spring Statement this March, the political focus will be on fiscal rules, economic forecasts and whether there is any scope for tax cuts. For millions of workers, however, the real tax increase has already happened – and it’s been going on for years.

Frozen tax thresholds making a pay rise a pay cut

Since April 2022, income tax thresholds have been frozen and they are not due to rise until at least 2031.

Over the same period, prices have surged, wages have risen in nominal terms. Despite the rhetoric that growth is finally returning, many people are seeing living standards continuing to be squeezed.

The reason? Fiscal drag. As pay increases it pushes earnings into higher tax bands and a larger share of income is taken in tax even though workers are no better off in real terms. Millions of people are now paying higher-rate tax not because they have become wealthier, but because the tax system has failed to keep pace with inflation.

The Institute for Fiscal Studies has warned the freezing of thresholds amounts to one of the largest stealth tax rises in modern Britain.

The effect can be startling when the numbers are set out in full. Take a worker earning £50,000 in 2021. After income tax and National Insurance, their take-home pay was roughly £37,500. That figure represents their real baseline before inflation began to accelerate. Fast forward to today and assume that worker has received what looks like a healthy series of pay rises, lifting their salary to £60,000 — a 20 per cent increase that many would consider generous.

On paper, that rise appears to have done its job. Their net pay increases to around £42,000. But because income tax thresholds have remained frozen, a far larger slice of that salary is now taxed at higher marginal rates.

Once inflation is taken into account, the picture changes completely.

Prices are now around 25% higher than they were in 2021. To enjoy the same standard of living as £37,500 provided four years ago, that worker would now need almost £46,900 in take-home pay. Instead, they are more than £4,800 short. In real terms, their living standards have fallen by just over 10 per cent, despite a substantial pay rise.

That gap alone equates to more than £400 a month, and for households with children, student loans or tapered benefits, the shortfall can easily approach - or exceed - £600 a month.

This is why so many workers feel as though they are running harder simply to stand still.

Rising mortgage costs, higher rents, council tax increases and expensive food and energy bills all compound the problem. Frozen child benefit thresholds and student loan repayments further erode net income, particularly for middle-income families. The tax system is amplifying the cost-of-living crisis rather than cushioning it.

Had tax thresholds risen in line with inflation, the outcome would look very different. More of that £60,000 salary would still sit within the basic-rate band, National Insurance would bite less aggressively and take-home pay would be several thousand pounds higher. The same worker would be close to breaking even in real terms, rather than suffering a double-digit drop in living standards. This is precisely why fiscal drag is so effective as a revenue-raiser: it increases the tax take without the Chancellor ever having to announce a tax rise.

That is why the Spring Statement matters, even though it is not a full Budget.

With Labour now in government, Chancellor Rachel Reeves has placed an emphasis on stability and fiscal discipline. But unless frozen thresholds are addressed, households will continue to feel poorer regardless of wage growth or headline tax rates. The central question for many workers is no longer whether they are getting a pay rise, but why that rise no longer translates into a better standard of living.

In the absence of immediate tax reform, attention is increasingly turning to what employers can do to soften the blow. Well-designed employment packages can make a material difference to take-home pay without pushing workers further into higher tax bands. Higher employer pension contributions, salary sacrifice arrangements and tax-efficient benefits allow employees to retain more of what they earn at a time when marginal tax rates are quietly rising. In an era of frozen thresholds, tax efficiency has become an integral part of remuneration, not a perk on the margins.

The uncomfortable truth is that a pay rise which fails to outpace inflation and fiscal drag is not a pay rise at all, but instead, a slower form of pay cut. As the Spring Statement approaches, the challenge is that, unless something drastic happens, millions of workers will remain and continue to become measurably worse off.

If you would like some more information about how tax increases are affecting you, your employees or your business, contact Monahans to see how we can help.

Dominic Bourquin