The budget on 3rd March is Rishi Sunak’s first chance to ‘make his mark’ on fiscal policy. To date he has been spreading the cash around, with the furlough scheme, discounted meals in restaurants, and an uplift to Universal Credit. He’s considered by many to be the most popular minister in the Cabinet and the bookies are offering good odds on him being the next Prime Minister. This budget will be his first real test of whether he can balance politics and economics, but what options are available to him?
Despite Boris Johnson’s professed dislike of the word, I think some austerity is on the cards. The most likely option is a public sector pay freeze, with exemptions for ‘deserving’ (as defined by the government) occupations such as NHS staff. Other occupations may be spared a pay freeze too – perhaps teachers and police to make up for not prioritising them for vaccinations.
There has also been a £20 per week temporary increase to Universal Credit to help people through the coronavirus crisis. Whilst I don’t expect this to be cut immediately, I do think a deadline will be set for its removal.
The Chancellor needs cash, and the vast array of taxes in the UK gives him plenty of scope for raising money.
Insurance Premium Tax
Insurance Premium Tax is charged on short-term insurance policies sold in the UK, such as car, buildings and contents insurance. It’s a bit like VAT, in that it’s calculated as a percentage of the sales price (in this case the premium) and brought in just over £6bn in 2020.
There are two nice things about IPT from the Chancellor’s point of view:
Compulsory purchases: Many insurance policies are purchased as a result of legal or contractual obligations. For example, if an increase in IPT adds £10 to your car insurance, will you stop driving, or drive without insurance and risk having your vehicle seized and destroyed? Probably not, and £10 over millions of policies adds up to a hefty sum.
Unknown tax: Hardly anyone outside the insurance industry seems to know about IPT, so a small increase is unlikely to result in negative headlines in anything other than insurance trade publications.
The Chancellor’s predecessors – particularly George Osborne – made a virtue out of repeatedly cutting corporation tax, which is charged on the profits made by UK limited companies (and a few other organisations). It raised £53bn in 2020, and is currently set at 19%.
I think the most likely and sensible option here is that corporation tax will be increased gradually, by perhaps 1 percentage point each year, until it is closer to 25%. This would raise a lot of money over the life of the current Parliament, without dropping a huge tax rise all in one go.
The other advantage for the Chancellor is that corporation tax hits companies rather than individuals, and therefore it doesn’t feel like he’s taking money out of the pockets of voters – unless of course you happen to be a shareholder.
Whilst I think the Chancellor is far too politically astute to hike income taxes in the middle of a pandemic, I do think he will make some tweaks to the bands which determine how much of your income is charged at the different rates of income tax. In particular, freezing the higher rate band at £50,000 would mean that gradually more people will pay some tax at 40%. This is a high enough amount not to lose him too many votes, whilst still raising more money over time.
As with income tax, I don’t expect an across the board hike to national insurance. However, there is a supposed discrepancy in that the self-employed pay a lower level of national insurance contributions than the employed. Historically this was because the self-employed received fewer benefits – particularly when it came to the state pension – and so this was a way of making things fairer. However, when the Chancellor announced the support scheme for the self-employed (sort of like furlough, except far less generous and with more exemptions), he hinted quite strongly that this might mean the end of lower rates of national insurance for the self-employed, and the pandemic would give him some political cover to push this through.
I don’t think a rise in national insurance for the self-employed is a done deal though, as raising taxes on small businesses is a very un-Conservative thing to do. Philip Hammond considered this a few years ago and had to back down due to opposition from backbench MPs.1 Equalising the rates in one go would be a tax increase of 3 percentage points (9% to 12%) on earnings from £9,501 to £50,000, or up to £1,215 a year. As dividends are not subject to national insurance, a big increase might convince more sole traders to incorporate as a limited company, which may end up reducing the overall tax paid.
Capital gains tax
Capital gains tax (CGT) is usually levied on the difference in price between the price you paid for an asset and the price you sold it for (there are some major exemptions, such as your primary residence and transfers between spouses, and assets held in ISAs). Effectively, it is a tax on wealth rather than income, and like income tax most people have a tax-free allowance every year.
One strikingly obvious problem in the current system is that capital gains are taxed at a lower rate than income, which favours those with wealth (usually older people, as it takes time to accumulate) over income. For example, if you are a higher rate taxpayer, you will pay 40% income tax, but only 28% (residential property) or 20% (anything else) capital gains tax. Changing the rates so that capital gains are taxed at the same level as income could raise a lot of money, and would hit the wealthiest hardest.
Pensions tax relief
At present, most people are entitled to tax relief on their pension contributions at their marginal tax rate, and employers also benefit from reductions in national insurance. Together this relief costs around £40bn a year, a disproportionate amount of which goes to higher rate taxpayers (the more tax you pay, the more relief you get). One of the easiest ways of retaining more taxes would be to restrict this relief to the basic rate, i.e. everyone would get 20% relief. Alternatively, if the Chancellor wanted to be generous and progressive, he could introduce a flat rate of relief higher than the current 20%. This would mean that most people would receive more tax relief than they do at present – perhaps encouraging them to save more for retirement – at the cost of a significant reduction for higher earners.
Other options for tinkering with pensions include reducing the annual amount that can be added to a pension and receive tax relief, or reducing the lifetime amount that can be held in a pension.
There are lots of options available to the Chancellor, some of which he may avoid for political reasons. Psychic Paul’s Political Predictions for this budget are:
- Public sector pay freeze in real terms, with exemptions for the NHS and possibly policing and teaching.
- Increased national insurance contributions for the self-employed, from the 2021/22 tax year onwards.
- Incremental increases to corporation tax, largely reversing the Osborne cuts.
- Freezing the income tax higher rate band, and possibly the personal allowance.
- Tinkering with capital gains tax rates and bands, but no wholesale reform.
- Reductions in pension tax relief, either in the percentage relief, the annual allowance or the lifetime allowance.
- Deadline given for the withdrawal of the increase in Universal Credit.
Whatever happens, I expect the budget to leave a lot of people worse off individually, in the name of ‘restoring the nation’s finances’.