This year, the UK and many other nations commemorated the 75th anniversary of VE Day. What many of us forget is that just a fortnight after the cessation of hostilities in 1945, the nation went to the polls in a General Election.
One of the first challenges the new Labour administration faced was the huge public debt that had been generated during the wartime effort. There was a fine balancing act between increasing tax revenues to tackle the debt while not penalising those who were at the front line of the efforts.
From an economic perspective, similar challenges face the Conservative government now as we consider what might happen to the economy once the coronavirus pandemic eases, and indeed if it remains as a chronic additional backdrop to life going forward.
With the Financial Times estimating that a budget deficit exceeding £337 billion could be the result of the crisis, tax rises are surely on the horizon.
As the government is under pressure to get the economy moving as soon as possible to preserve jobs, whilst substantial tax rises will arise, we doubt these will fall on businesses apart from possibly windfall taxes on sectors that have prospered under Covid-19.
Instead, it’s likely that an increased tax burden will fall on individuals and in particular those considered as wealthy. So, what options does the Chancellor have, and what can you do to plan for these changes?
Studies have found that British top marginal Income Tax rates rose sharply between 1938 and 1948, as this table shows:
||UK nominal marginal tax rate
Could the same happen again in 2020? Raising Income Tax is a quick and easy way of raising revenue as taxes on income dominate the tax take – generally accounting for over 50% of the overall revenue raised each year, so it is no surprise that movement on headline income rates is being considered. HMRC say that an increase of just one penny to income tax – by increasing the 20% rate to 21% is said to potentially raise £4.7bn each year. An increase in the basic rate of Income Tax from 20% to 25% would raise an estimated £23.5 billion this tax year – but either is politically controversial.
Not only does it break a manifesto promise, but it could also be seen to be targeting those key workers who have been so vital in recent months.
The Financial Times this weekend reported that the likely current year budget deficit as a result of the current crisis will be in the region of £337bn (estimates range from £300bn to £500bn), so this is a drop in the ocean. (For context, the OBR estimated the 2019/20 tax take would be £811.4bn.)
Adding 1p in the £ to the 40% rate has been said to bring in another £1bn p.a., and rolling the 40% band into the 45% rate would raise about £5 billion.
Interestingly, increasing the 45% rate to 46% would only net around £105m, so more popular measures aimed just at high earners may not yield anywhere near enough. An increase in the additional rate band from 45% to 50% would only raise about £525 million.
An alternative could be to reduce the rate at which an individual’s Personal Allowance starts to be restricted. At present, it is tapered away for those earning more than £100,000 per year and vanishes completely for those earning over £125,000. Other suggestions have been to adjust the income tax personal allowance down for all – although this seems politically toxic as it would raise effective rates most for the lowest paid.
With different rates applying to bands of earnings and types of employment, reforming NICs has been on the government’s agenda for some years.
One of the options the Chancellor could consider is scrapping the NICs upper earnings limit. Currently, employees pay 12% NICs on their earnings between £9,501 and £50,000, but just 2% on income above this level.
If a flat rate of 12% NICs was introduced, someone earning £100,000 would pay approximately £5,000 more — even if Income Tax rates were left as they are.
In addition, Rishi Sunak has already hinted that self-employed workers can expect to see their rate of NICs rise. Self-employed people earning more than £9,501 a year pay Class 4 NICs at 9%, compared to employed workers who pay 12%. This is an inconsistency that Mr Sunak said was “now much harder to justify”.
Self-employed NICs was expected (before the crisis) to raise £3.4bn in 2019/20; that is £5.6bn less than if self-employment income was taxed at the same rates as employment income. This would still leave a big tax advantage for the self-employed as they would still face no equivalent of employer NICs.
Pensions tax relief for higher earners cost the Treasury £38 billion in 2018/19, making it the most expensive tax break. There was speculation before this year’s Budget that this might be an area the Chancellor would reform, and so this could be a key area of change.
Restricting tax relief on all pension contributions to the basic rate of 20% has previously been estimated to raise more than £10 billion per year.
While many Conservative voters would be affected, cutting pension tax relief for the wealthy is unlikely to elicit much public sympathy at a time when so many have suffered economically and personally.
The Chancellor may also decide to end the ‘triple lock’ on annual increases to the State Pension, which are guaranteed to be the higher of inflation, earnings growth or 2.5%. Reducing the 2.5% figure could produce annual savings of £8 billion, according to a leaked Treasury document.
With changes to pension tax relief in the Chancellor’s sights, carrying out pension planning sooner rather than later may be prudent in case of an emergency Covid-19 Budget.
Another method the post-war government used to increase tax revenue was to raise the rate of Inheritance Tax.
Then called ‘estate duty’, the rate was raised to 80% after the Second World War and reached a peak of 85% in 1969.
As IHT only brings in about £5.4 billion a year, the government may consider abolishing it and replacing it with a system where capital transfer tax is levied whenever assets are transferred — either on death or in life – just as in the 1970s and 1980s. In the USA every person has a lifetime cumulative limit on gifting, this could be introduced here.
The Chancellor could also align more closely the tax rates charged on gains with those charged on income.
Currently, basic rate taxpayers pay Capital Gains Tax (CGT) at 10% on assets apart from property, where they pay 18%. Higher and additional rate taxpayers pay 20% and 28%. Individuals also have a CGT allowance, which is currently £12,300.
By contrast, income for the same groups is taxed at 20, 40 or 45% above the Personal Allowance of £12,500.
Just Tax, a report from The Institute for Public Policy Research published on 9 September 2019, estimated the government could raise an extra £90bn over the next five years by taxing capital gains at the same rate as income.
Many experts believe that the CGT rate will increase — possibly to a flat rate of 28% — and that the CGT annual exemption could also be abolished for higher and additional rate taxpayers.
Property and Wealth taxes
After pensions tax relief, the Exchequer’s second most costly giveaway is Private Residence Relief which exempts people from paying tax on gains when they sell their main home. This relief was worth £26.7 billion in 2018/19.
Some tax experts think there is a risk the relief could be restricted. Indeed, there were rumours before Philip Hammond’s first Budget that Private Residence Relief could be capped at £225,000 per transaction. If this happened, anyone making significant gains on a property would be subject to Capital Gains Tax at 28%.
Introducing a new wealth tax, either as a one-off or an ongoing levy on people’s assets (a bit like the Mansion Tax we all talked about some years ago), is another option the Chancellor may consider. Many countries have a version of this in place.
Nick O’Donovan, senior lecturer in the Future Economies Research Centre at Manchester Metropolitan University, says: “If the costs of the crisis are added to the public debt, to be serviced out of conventional future tax revenues, we are essentially saying that those who engage in economic activity after the crisis should pay for the emergency healthcare spending and economic bailout enjoyed by taxpayers today.”
He calculates as an example a one-off levy of 2% on UK households’ net wealth an “NHS surcharge” would raise £300 billion to cover the cost of the crisis. Again, there are parallels with 1945 here as this is what some European countries introduced after World War II.
It could be charged with some notice or perhaps secured against assets where it would be debited upon sale or transfer.
If ever popular support were to be sought for introducing a raft of difficult measures, now is the time and we all I am sure have sympathy for this given the national circumstances.
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Nevertheless, individuals and their families need to make their own decisions based upon their own views and circumstances. With such a significant debt accumulating, clearly it is likely the Chancellor will have to take measures to increase revenue sooner rather than later. So, with these possible changes on the horizon – perhaps even in an emergency Budget – now could be the time to assess where you stand and if appropriate, for some prudent action.
If you would benefit from a financial review, we are here to help. Please email your usual advisor or send us a message via the HFMC Wealth website or call us on 020 7400 4700.