Short-term gain, long-term pain?

Rishi Sunak has spent most of the last year handing out money.  Fiscal measures in response to the pandemic already add up to some £280 billion (about 13% of the national income), and might grow to £407 billion by the time all is said and done.  As a result, Sunak is as popular as any Chancellor in recent memory.  That may change, once the government’s focus shifts from economic life support to repairing the public finances, part of which will inevitably mean tax rises.  But though the Chancellor announced two distant tax-raising measures, yesterday’s Budget injected the morphine of more short-term spending and tax cuts, deferring the pain of higher taxes for now.

Deep freeze

The first of the major tax changes announced was a freeze of personal tax allowances, as follows:

  • Though the income tax personal allowance and higher rate threshold will increase in line with inflation next month (to £12,570 and £50,270 respectively), they will then be kept at those levels for a full 5 tax years until April 2026. This will eventually create an extra 1 million higher rate taxpayers.

 

  • The standard Lifetime Allowance for pensions (£1,073,100) will be frozen until April 2026. Entitlements to Fixed Protection 2016 and Individual Protection 2016 may be even more valuable as a result, and it is still possible for some to apply for these.

 

  • The annual exempt amount for capital gains tax (£12,300 for individuals) will be kept at that level until April 2026.

 

  • The nil rate band (£325,000) and residence nil rate band (£175,000) for inheritance tax will both also be frozen at those current levels, also until April 2026. The nil rate band was last increased in April 2009, for those keeping track.

 

  • Pension and ISA contribution allowances will remain the same next tax year, though there were no announcements beyond then.

As incomes and assets grow over time, the value of these allowances and exemptions will diminish in real terms, an effect known as ‘fiscal drag’.  In the short term, these changes will almost certainly go largely unnoticed and raise small amounts.  Yet in the long term, they will raise some real money for the Treasury, especially from higher earning and wealthier individuals.  The Government expects existing personal taxes at their existing rates to yield an extra £9 billion per year by 2025/26, relative to had the allowances and exemptions kept pace with inflation.

More tax on ‘big’ business

The second of the major tax changes announced was an increase to corporation tax rates for businesses with profits over £50,000 per year, but only from April 2023.  This time last year the Chancellor cancelled a promised corporation tax cut to 17%.  Now some businesses will eventually face a main rate of corporation tax of 25% on profits, up from 19% today.  For those that own their own businesses, tax-efficient profit extraction (such as via employer pension contributions) may become all the more important.

Only some businesses will be affected though, as the government will be returning to the more complicated corporation tax system in place up until April 2015.  Smaller companies will carry on paying 19% and larger businesses will pay the main 25% rate, with tapered rates in-between.  However, the thresholds for smaller and larger firms will be much lower, at just £50,000 and £250,000 respectively (instead of £300,000 and £1.5m back then).  All told, relative to the status quo, the Government expects extra corporation tax of £17.2 billion per year by 2025/26.

While the Chancellor argues that headline rates of corporation tax will remain internationally attractive, the UK corporation tax code has fewer allowances and exemptions.  That means a broader corporation tax base, so the tax will yield a meaningful amount even by international standards.  In the long term then, we will be a long way from the Singapore-on-Thames of which some Conservatives dream, other than, perhaps, for multinational firms capable of shifting profits across borders.

Hands tied, but still more to come?

These tax rises have been adopted because the Chancellor is left with very few other powerful levers to pull.  The Conservatives have ruled out a return to austerity, and promised in their 2019 manifesto (pre-COVID, of course) not to raise the rates of the 3 biggest source of tax revenue – income tax, national insurance and VAT.  Even with everything that has happened over the last year, the Chancellor unequivocally re-iterated that same promise today, tying the government’s hands when it comes to other potential future tax rises.

On that note, there was, as expected, no mention of any new wealth taxes (see our article on these earlier in the week).  And besides the aforementioned deep freezes, there were no changes of any note to pensions, capital gains tax or inheritance tax.  The recommendations of the Office of Tax Simplification (OTS) on reforms to capital gains tax and inheritance tax continue to go unheeded, for now at least.  Attentions may turn back to these later in the year at an expected Autumn Budget, or even later this month.  The OTS is expected to publish a second report on capital gains tax shortly, and the government is expected to announce a series of further tax consultations on 23 March.  These may paint a clearer picture of wider plans for tax policy.

Giveaways

In the short term, the government will be borrowing even more money to extend its COVID-19 income support schemes (CJRS and SEISS for those that like acronyms), recent business rates, VAT and stamp duty land tax cuts, and temporarily higher levels for some benefits like universal credit.

Of particular relevance to clients planning property purchases, the so-called “stamp duty holiday” is being extended to all buyers until 30 June 2021.  Cue a mad rush to meet that deadline instead, even if the full force of stamp duty land tax will only re-apply from 1 October 2021.

Finally, while businesses may not be enthused by the prospect of higher corporation tax in the future, in the meantime, the new and catchily named “super deduction” may be of interest.  This is intended to bring forward investments in plant and machinery that might kickstart the economy.  The government expects this to give businesses back a chunky £12 billion per year for 2 years.

The state of the public finances

Totting everything up, on top of a deficit of £355 billion in 2020/21, the government expects to have to borrow another £234 billion in 2021/22, or nearly £9,000 per capita across the 2 years.  These are record levels of borrowing outside of wartime by any measure.  But much of that will be borrowed (indirectly) from the Bank of England through Quantitative Easing (QE), and interest rates and inflation have fallen sharply over the last year.  As a result, government debt interest (net of the effect of QE) is actually less today (as a portion of national income) than at any time since World War 2.

Therefore, as long as interest rates and inflation remain low, the re-opening of the economy over the coming months goes to plan, recovery ensues and the pandemic goes and stays away, there appears no great urgency to balance the books.  The tax rises announced yesterday and the tax rises still to come can all wait.  But if the last year has taught us anything, it is that the best laid plans can get knocked off course.  Government bond yields have already surged over the last month or so.  If that continues, inflation really picks up or the virus mutates, the day of reckoning for the public finances, for higher taxes and for Rishi Sunak’s popularity may come sooner.

If you have any questions about how the spring budget may impact your finances, please get in touch. 

 

All statistics cited are from the following official government Budget documents or are the author’s own calculations based on those statistics and a UK population of 67 million:
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/966161/Budget_2021_Web_accessible.pdf
https://obr.uk/download/economic-and-fiscal-outlook-march-2021/

About The Author

John Hill
John joined Saunderson House in 2011 after graduating with a first-class honours degree in European Social and Political Studies ...
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