The budget is approaching and in recent years there have been leaks and reports to help reduce the impact of any surprises, but this year it is very difficult to predict what the Chancellor of the Exchequer has planned, let alone what rabbits he has kept up his sleeve, writes Neil Jones, tax and wealth specialist at Canada Life.
With the UK still in lockdown there are a number of options. He could go for tax increases to help reduce borrowing, tax decreases to boost the economy, use the opportunity to reform tax or make temporary changes to see us through to the next budget, scheduled in Autumn.
While many commentators are talking about tax increases to cover the cost of covid, as interest rates are virtually zero, and potentially heading negative, the cost of servicing any borrowing is low so the strain on the economy will only become an issue as rates increase. It is also worth noting that when putting money into the economy the government has been buying its own debt.
In the past we have seen governments control inflation by increasing and decreasing interest rates, however with the rate at the current level and likely to remain low for the foreseeable future, this is now not possible. Another way of controlling inflation is by increasing or decreasing taxation.
If you want the populous to have money to spend, reduce tax, and if you want to reduce their spending power, increase tax. The argument for tax reductions is therefore a logical one to some people but some form or reform or increase may be needed for international investors to maintain confidence in the UK economy.
As the nation recovers from covid and the vaccination programme strides ahead, we will see a gradual return to pre-covid normality which should lead to an economic boost as people start spending again.
The government need people to spend money in order to generate tax revenues and the hospitality and travel sectors will welcome this, however we could also see increase in receipts for fuel duty as a result of the opening up of this sector.
It is a possibility that we could see another incentive scheme, maybe not a re-run of the Eat Out to Help Out scheme, which ironically probably increased the spread of covid, but something is needed to get people spending.
Let’s look at some of the options available to Rishi Sunak regarding wealth taxes.
Income tax and National Insurance
The Conservative election manifesto pledged not to increase these taxes, along with VAT, and reports suggest that Sunak is going to honour that promise. Cuts to National Insurance and Income Tax are expensive so unlikely but if he wanted to increase revenues he could play around with the thresholds and bands.
The income tax bands were confirmed in the spending review last year so I don’t think these will changes, however I wonder if a new upper-upper threshold for National Insurance could be accommodated without breaking the promise as current rates will remain unchanged.
A temporary threshold for higher earners could be used to pay covid-related debt and be seen as a good fit with the electorate as it would only impact high earners – the question around this would be how long it would need to last.
Again, reports have emerged over recent weeks that the UK government is going to honour the pledge of not increasing VAT, again as part of the pledge made in the Conservative manifesto.
If there was to be an incentive to encourage people to spend then maybe a temporary, short-term reduction in VAT is the answer. This would be expensive but it would help boost the economy after the vaccination programme and could provide a sweetener should any of the other tax changes be detrimental.
As travel and hospitality have not returned to pre-covid levels and is unlikely to until the completion of the vaccination programme, the temporary cut for tourism and hospitality should remain and be reviewed later in the year.
Capital gains tax
There has been much written about capital gains tax and I think it is fair to say that changes are expected, it is just a matter of when and in what direction. The tax’s objective and its target is muddled and needs clarity.
I think changes could be on the cards in the short term whilst there is a wider reform planned and consulted on; maybe for later in the year. In the short term we could see an increase in rates bringing them nearer to income tax rates, however this would not allow for any indexation so maybe keeping them a few points below seems favourable.
I also expect the annual exemption to be dramatically reduced as why should the wealthy have two allowances; the personal allowance for income and the annual exemption for capital gains. This could see the current £12,300 ($17,058, €14,200) move to around the £2,000 mark if some are to be believed.
I am not in favour of the much-discussed wealth tax due to the fact that a lot of wealth in the UK is held in people’s homes and pensions.
Wealth in these areas does not necessarily mean that these people have the ability to pay a tax and would mean that the tax advantaged pension wealth is taxed, so effectively targeting a wealth tax would difficult. The opportunity to overhaul and reform capital gains tax could see capital gains tax become a pseudo wealth tax.
If there is reform or more significant changes coming later in the year then why bother changing the structure of the tax at this stage, incurring all the costs involved with structural changes.
Many nations, such as Netherlands have abolished capital gains tax and levy income tax against investments. Similar structures could be less complicated and cheaper for HM Revenue and Customs (HMRC) to administer however such dramatic reform would undoubtedly require a significant period of consultation.
An almost universally disliked tax and a headline grab could see a significant reform to inheritance tax, but I am not convinced he will go this far. This may form part of the wider plans for capital gains tax as there is a distinct interaction between the two taxes and changes to one will have an impact on the other.
With a rate of 40% there is little scope to increase it without damaging the government’s position with the electorate, so again could be largely left untouched with the prospect of consultations and changes later in the year.
I say ‘largely’ left untouched as there certainly needs to be some changes. One example is the interaction with capital gains tax. The ability for a spouse or civil partner to inherit an asset free of both capital gains tax and inheritance tax is very generous so I would expect this to be changed.
It could mean that where the transfer on death is exempt, so when an estate is left to a spouse or civil partner, they will acquire the asset and capital gains tax will be based on the original acquisition cost.
This doesn’t seem particularly unfair but will generate tax revenues when the assets are eventually sold.
As with every budget there is speculation around this; could 2021 finally be the year we seen a single rate of tax relief on personal pension contributions?
Again there is need for reform and the feeling is stronger this year than it has been for a while, however either way I would hope that an announcement would be made to say whether the current system would be maintained or not to end the rumours in the future.
Pensions are a favourite area of change in a budget and we need stability.
One tactic employed by some of Mr Sunak’s predecessors is to signpost changes giving people the opportunity to plan which generates tax revenues in the short term. This could be an option for capital gains tax as changes could have a significant impact on investors, especially those who hold a portfolio heavily pregnant with gains.
In order to avoid the changes we could see investors realising gains and seeking shelter in tax wrappers that are not subject to capital gains tax. Indeed, we have already seen an increase in CGT receipts and this could be caused by the expectation of rate increases or the reduction of exemptions.
‘Logical, clear and fair’
Going back to the Conservative Party election manifesto, not only did they pledge not to increase income tax, VAT and
National Insurance but it also stated to “…redesign the tax system so that it boosts growth, wages and investment and limits arbitrary tax advantages for the wealthiest in society”.
This reminds me of a quote by economist Myron Scholes who wrote “success is achieved when the tax rules subsidise activities that benefit society as a whole more than they benefit the individuals engaging in the activities”.
Whatever the Chancellor of the Exchequer decides, I hope that he helps create a logical, clear and fair tax system – a system that targets those people who can and should pay the tax.
This article was written for International Adviser by Neil Jones, tax and wealth specialist at Canada Life.