Inflation Quietly Raises Your Tax Bill — And Nobody Has to Vote For It
Nobody announced it. Nobody campaigned on it. But when prices rise, so does the government's take — twice over, and out of the same pocket as everything else.
By Pavel Penev, MScFounder, TradeWize · 10+ years trading the marketsYou have probably noticed the shop getting dearer. Everyone has. What almost nobody notices is the second thing that happened at the same time: you started paying more tax. Not because a rate went up — no rate went up — but because most of the tax you pay is written as a percentage of a number that keeps growing, and because the thresholds that decide how much of your pay gets taxed have been sitting perfectly still while your salary walked past them. This is the quietest tax rise there is, and it arrives every single year without a debate, a vote, or a press conference.
The 10-second version
VAT is a percentage of the price, not a fixed amount. So when prices rise 20%, the government collects about 20% more from the same shopping — at exactly the same rate. Meanwhile income-tax thresholds are frozen, so a pay rise that only matches inflation can still push you into a higher band. Both are real tax rises. Neither one has to be announced.
A tax that's a percentage, not a price
Start with the mechanism, because the mechanism is the whole story. VAT — value-added tax, the thing baked into nearly every price you see in the UK and across Europe — is charged as a percentage of what something costs. In the UK that's 20% on standard-rated goods. Not 20p. Not £4. Twenty per cent of whatever the price happens to be that day.
Compare that to a tax written as a fixed amount — a flat duty of, say, 50p per item. To collect more from a fixed duty, a government has to raise it, which means legislating it, announcing it, and defending it to people who vote. A percentage needs none of that. It just sits there, attached to a number that inflation is already pushing upward, and collects more every year on its own. A percentage is a wonderfully low-maintenance thing to own.
The same trolley, more tax
Here's the arithmetic on a single shop. Take £100 of standard-rated goods. Add 20% VAT and you pay £120, of which £20 is tax. (Useful trick: when VAT is 20% and it's already inside the price, the tax is the total divided by six. £120 ÷ 6 = £20.) Now run five years of fairly ordinary 3% inflation. The identical trolley of goods now costs £115.93 before tax and £139.11 at the till — and the VAT inside it is £23.19.
The same goods, five years apart, at a 20% rate that never once changes. The tax collected goes from £20.00 to £23.19 — 16% more money out of you, from a rate that stood still the entire time. Multiply by every household in the country and you have a substantial revenue increase that appeared in nobody's manifesto.
Scale that up and it stops being loose change. UK VAT receipts are forecast at £179.6 billion in 2025-26 — about 14.6% of everything the government collects, and roughly £6,250 per household. That number climbs with prices whether or not anyone touches the rate, which is precisely why chancellors are so relaxed about promising not to raise VAT. They don't need to.
Set your monthly spend on taxed goods, then let inflation run. The rate never changes — watch the tax anyway.
Same 20% rate, same trolley, same you. Nobody legislated a rise, nobody campaigned on one, and the government still collects £127.42 more from you every year. VAT at 20%, already inside every price you see.
Baked-in vs added-on changes what you see, not what you pay: the tax inside any total spend is that total × rate ÷ (1 + rate) either way. Assumes your spending keeps pace with prices and stays on standard-rated goods.
Fiscal drag: the pay rise that isn't
The second mechanism is sneakier, and it has a name that sounds like a piece of dull machinery precisely because it is one: fiscal drag. Income tax has thresholds — you pay nothing below one, the basic rate above it, the higher rate above another. In a sane world those thresholds would rise each year with prices, so that a pay rise which merely keeps up with inflation doesn't change your tax situation at all.
In the UK they haven't moved since April 2021. The personal allowance is stuck at £12,570 and the higher-rate threshold at £50,270, and the freeze now runs to April 2031. Had they simply tracked inflation, they'd be roughly 28% higher by now. So every cost-of-living pay rise walks you a little further up a ladder whose rungs have been nailed in place.
A £44,000 salary rising 4% a year — enough to keep pace with prices and not a penny more. In today's money it buys exactly what it always did (the flat dashed line). But the frozen £50,270 threshold doesn't care about today's money, and four pay rises later you're a higher-rate taxpayer who is no better off than when you started.
This one isn't an accident, and to its credit the government doesn't really pretend otherwise — it's costed, published and forecast like any other policy. The Office for Budget Responsibility has put the freezes at £29.3 billion a year by 2027-28, which it notes is equivalent to putting 4p on the basic rate of income tax. It also expects them to create about 3.2 million new taxpayers and 2.1 million new higher-rate taxpayers who would not have existed had thresholds simply moved with prices. A 4p rise in the basic rate would be front-page news for a week. This was a line in a spreadsheet.
Learn it by doing
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Try the free lesson →Both bites land on the same pound
The two mechanisms aren't alternatives. They stack, and they stack on the same money — one at source, one at the till. Follow a £1,000 pay rise through both, for someone fiscal drag has just pushed over the higher-rate line.
Above £50,270 the marginal rate is 40% income tax plus 2% National Insurance, so £580 of the £1,000 reaches your account. Spend it on standard-rated goods and VAT takes another £97. About £483 of the original £1,000 survives to buy anything. In fairness, the VAT step is a worst case — the standard rate covers roughly half of household spending, and food, children's clothes and books are zero-rated — so the true bite sits somewhere between this and nothing.
And remember what that £1,000 was for. If it was a cost-of-living rise, it wasn't a reward — it was compensation for prices having already gone up. You are being taxed at the higher rate on money whose entire job was to leave you exactly where you were.
Is this a conspiracy? Honestly, no.
It's worth being fair here, because the fair version is more useful than the angry one. Fiscal drag is a deliberate policy choice — openly forecast, repeatedly extended, and chosen specifically because it raises money without the political cost of announcing a rate rise. Call that cynical if you like; it isn't secret.
VAT rising with prices is a different animal. It's not a scheme at all — it's just what a percentage does. And there's a genuine argument on the other side: governments buy things too, and their costs rise with inflation like everyone else's. A tax take that stays flat in real terms isn't obviously outrageous. Governments have also cut VAT when it suited them, temporarily and otherwise.
The point isn't that someone is robbing you. It's that a meaningful part of your tax bill now moves without anyone deciding it should, which means it never gets argued about — and things that never get argued about have a habit of drifting.
What this looks like where you live
The mechanism is universal; the numbers aren't. Every EU member state must charge a standard VAT rate of at least 15%, and the actual rates run from Luxembourg's 17% to Hungary's 27%, averaging 21.9% across the bloc.
| Country | Standard rate | How you meet it |
|---|---|---|
| Hungary | 27% | Highest in the EU — baked into the price |
| Finland | 25.5% | Baked into the price |
| Croatia, Denmark, Sweden | 25% | Baked into the price |
| EU average | 21.9% | EU minimum permitted is 15% |
| UK | 20% | Baked into the price |
| Germany | 19% | Baked into the price |
| Luxembourg | 17% | Lowest in the EU |
| United States | ~7.53% average | No VAT — sales tax added at the till |
The US is the outlier, and not only on the number. It has no VAT at all: sales tax is set by states and localities, averages 7.53% combined, runs to 10.13% in Louisiana, and doesn't exist at state level in Delaware, Montana, New Hampshire or Oregon. Crucially, it's added at the checkout rather than hidden in the shelf price — which is why Americans watch this happen and Europeans mostly don't.
American readers get a real reprieve on the other half of this, though. US federal tax brackets have been indexed to inflation since the 1985 tax year, so bracket creep — the US name for fiscal drag — is largely handled automatically. Largely, not entirely: since 2018 the indexing uses chained CPI, which tends to grow about 0.25 percentage points a year slower than the older measure. So the brackets do still creep, just in slow motion rather than the UK's frozen-solid version.
What you can actually do about it
Let's be honest about the limits first: you cannot opt out of VAT, and you cannot personally unfreeze a tax threshold. Anyone selling you a clever trick around either is selling you something. What you can change is how much of your money is sitting in the one place where this quietly compounds against you.
- Notice which pot is exposed. Cash in a current account meets rising prices with nothing to offset them — it just buys less each year while the tax inside your spending grows. That's the pot this hurts most.
- Own things whose prices rise too. Companies put their own prices up with inflation, which is why a broad, low-cost index fund has historically outrun rising prices over long stretches. It isn't a hedge against tax; it's a hedge against the thing that drives the tax.
- Use tax-advantaged accounts where your country offers them. Rules vary enormously — ISAs, 401(k)s, IRAs, SIPPs, PEAs and the rest all work differently — so check yours rather than copying a rule from another country's internet.
- Judge everything in real terms. A pay rise, a savings rate, a return: the only version that ever bought anything is the one after inflation. Nominal numbers flatter you, and now they can promote you into a higher tax band while doing it.
- Keep an eye on the marginal rate, not the average. Fiscal drag works by moving you between bands. Knowing which band your next pound lands in is what makes pension contributions and salary sacrifice worth actually calculating.
None of that is a way to beat the government. It's a way to stop volunteering. The people who lose most to a stealth tax rise are the ones who never noticed there was one, because the defence — owning assets that move with prices — is something you have to do on purpose and in advance.
Frequently asked questions
Is inflation a tax?
Not formally, but it functions as one in two ways. Because VAT and sales taxes are percentages of price, rising prices automatically increase what governments collect without any rate change. And because income-tax thresholds are frozen in some countries, inflation-driven pay rises push people into higher bands. Economists sometimes also call inflation itself a tax on cash holdings, since it transfers real value from savers to borrowers — governments typically being the largest borrowers of all.
What is VAT in simple terms?
VAT (value-added tax) is a consumption tax charged as a percentage of a product's price. It's collected in stages along the supply chain, but the cost ultimately falls on the final consumer. In the UK and EU it's included in the displayed price, so you rarely see it as a separate line — unlike US sales tax, which is added at the checkout.
Does the government collect more VAT when prices rise?
Yes, automatically. VAT is a percentage of price, so if the same goods cost 20% more, the tax collected on them is 20% more too — at an unchanged rate. No legislation or announcement is required. This is why VAT receipts tend to grow during inflationary periods even when consumption is flat.
What is fiscal drag?
Fiscal drag is what happens when tax thresholds don't rise with inflation. As wages rise nominally, more people are pulled into paying tax at all, or into higher bands, without any rate changing. It raises revenue in a way that's economically identical to a tax rise but politically much quieter — which is why it's often called a stealth tax.
How do I calculate the VAT inside a price?
For a 20% rate on a VAT-inclusive price, divide the total by six: £120 ÷ 6 = £20. The general formula is total × rate ÷ (1 + rate). At 19% that's total × 0.19 ÷ 1.19, and so on. To go the other way — adding VAT to a pre-tax price — just multiply by (1 + rate).
Are UK tax thresholds still frozen?
Yes. The personal allowance (£12,570) and higher-rate threshold (£50,270) have been frozen since April 2021, and the freeze currently runs to April 2031. Had they risen with inflation over that period they would be roughly 28% higher. The OBR estimates the freezes raise about £29.3 billion a year by 2027-28 — equivalent to a 4p rise in the basic rate.
Does the US have this problem too?
Partly. The US has no VAT, but state and local sales taxes are percentages of price and rise with prices in exactly the same way, averaging 7.53% combined. On the income side, though, US federal brackets have been indexed to inflation since 1985, so bracket creep is mostly automatic-adjusted away. The exception is that indexing has used chained CPI since 2018, which grows slightly slower than prices — so a mild version of the effect survives.
How can I protect my money from this?
You can't avoid consumption tax, and you can't unfreeze a threshold. What you can do is hold less of your long-term money in cash, which meets rising prices with nothing to offset them, and more in assets whose values tend to rise with prices — broad index funds being the standard workhorse. Using whatever tax-advantaged accounts your country offers helps on the income side. Rules differ by country, so check yours.
So that's the trick, and it isn't really a trick at all — just a percentage doing what percentages do, and a set of thresholds doing nothing at all. Between them they produce a tax rise that arrives every year, costs nobody an election, and shows up on your receipt as a number you've stopped reading. You can't vote it away. But you can stop leaving the money it feeds on sitting perfectly still, which is roughly the whole argument for investing in the first place.