With the 2014 Budget just around the corner, Moore Stephens’ Tax Technical expert David Williams considers the options for the Chancellor.
In preparing for his Budget on 19 March the Chancellor has to consider both technical changes to the tax system (such as new reliefs or adjustments to the calculation of taxable profits) and basic policy issues such as the rates and allowances applying to the various taxes.
Technical tax changes now tend to be announced at least a year in advance of their implementation. Following this pattern, most of the measures expected to feature in this year’s Finance Bill were announced in principle in the 2013 Budget. A subsequent period of consultation was followed by the publication of draft legislation in December 2013. The 2014 Budget is likely to include a similar range of proposals, which will then be developed over the coming year for inclusion in next year’s Finance Bill.
Reasons for action
In considering such proposals the Chancellor is subject to various constraints, which pull in different directions. The first is the need to be seen to be doing something. Because people are rarely entirely happy with things as they are, governments are (broadly speaking) elected to change things rather than keep them the same. A Chancellor who simply declared his intention of maintaining the status quo would doubtless be seen as rather pedestrian even by those voters who were not seeking any particular changes to the system.
If changes are to be made, there is clearly an incentive to ensure that they reinforce the government’s policy goals. These goals might be to encourage (or discourage) particular behaviours such as marriage, childbearing, healthy living, geographical mobility or environmental pollution. These behaviours might be seen as desirable or undesirable either on a prior grounds of moral or political conviction, or because they were considered to have an effect on the economic wellbeing of the country. Any serious politician has a vision of how, ideally, he or she would like the country to be. The Budget is an opportunity for George Osborne to move the UK in what he sees as the right direction, to the extent that he considers it politically feasible.
He could therefore seek to shape society, for example, by giving a tax relief for donations by business to community projects; or he could seek to boost economic output, for example by making increased capital allowances available to businesses for investment in plant and machinery. Or he could do both.
However, those measures, and similar measures, all have a cost in terms of tax revenue foregone, which brings them into conflict with one of the Chancellor’s major priorities, which is to reduce the deficit. Even if he decides he can afford to implement one or two such measures, he cannot please everybody. There is a political cost to disappointing particular interest groups, but sometimes it is outweighed by the political advantage of pleasing other groups. On the other hand, sometimes people will not very much mind seeing their particular interests ignored, provided no one else’s are recognised either. And sometimes, whatever people think, a thing is just ‘the right thing to do’ (to borrow a phrase which appears 3,923 times on the UK Parliament’s website). In that case any political fall-out must just be tolerated.
Reasons for not taking action
Against the impulse to take action the Chancellor has to weigh a number of factors that argue positively in favour of doing as little as possible. One is that doing something is almost always more trouble, at least initially, than doing nothing. Any policy measure he may choose to implement will probably require many pages of new legislation. Its enactment and application will absorb the scarce resources constituted by the time of ministers, MPs, policy advisers, parliamentary draftsmen, Treasury officials, HMRC officials and people in business.
Another significant factor is that the government came into office with an agenda of simplifying the tax system. Since then there have been some 1,900 pages of tax legislation in five Finance Acts, and countless pages of secondary legislation in statutory instruments. In theory this expansion of the legislation need not necessarily conflict with the simplification agenda, because brevity and simplicity are not exactly the same thing. However, the two concepts have a significant degree of overlap and even the government’s most loyal supporters could not realistically maintain that it had yet made significant progress in this area.
Sometimes, however, the policy objective will outweigh the desire for simplicity, and sometimes it will be right that it should. As Einstein suggested, things should be made as simple as possible but no simpler. Nevertheless, the situation has reached a stage where the Chancellor could be forgiven for wishing he had never mentioned simplification at all. He now has to decide whether it is worth attempting to undo the additional complexity of the last four years and then to tackle the complexity he inherited, or whether he would do better not to mention the subject again and hope no one else does either.
Tax rates and allowances
When the Chancellor turns from technical issues to consider adjustments to rates and allowances he will, once again, be looking at how to balance various constraints within which he has to work. If he increases rates to boost the revenue yield he may, at least initially, succeed in making further reductions in the deficit. On the other hand, it may be that tax reductions would stimulate the economy and lead to greater revenue (and a lower deficit) in the long run.
Reducing the rate of VAT and the basic rate of income tax may win votes, but on the other hand it may lose them if it prejudices the Chancellor’s reputation for prudent management of the economy and is seen as a ‘pre-election giveaway’.
Reducing tax for the rich has limited political appeal. As a result there is a ‘ratchet effect’ where it is easy to put up tax rates for the better off (or to reduce the thresholds at which they apply) but any subsequent attempt to reduce them, or even to adjust the thresholds for inflation, is met with protests that the rich are being favoured at the expense of the poor (even though they are still paying tax at higher rates than the rest of the population). The Chancellor’s reduction of the top rate of tax from 50% to 45% last year therefore showed considerable political mettle, quite apart from the merits of the decision in terms of equity and economic stimulus (on which opinions will inevitably differ).
It will therefore be interesting to see whether the Chancellor is prepared this year to tackle three further issues affecting better off taxpayers. One is that over recent years increases in the personal allowance have tended to be offset by reductions in the higher rate threshold, so that higher rate tax may be paid by a family with income only just in excess of £41,450. The second is the doubling of the rate between the basic and the higher rate, which arguably should be replaced by a much more gradual increase. The third is the completely anomalous marginal income tax rate of 60% that applies to taxable income between £100,000 and £118,880 because of the effect of the withdrawal of personal allowances for taxpayers with income over £100,000. From any viewpoint, whether one believes the tax system should be more or less sharply progressive, it cannot make sense for the rates to go from 20% to 40% then to 60% before falling back to 40% and then rising again to 45%.
Who’d be the Chancellor of the Exchequer? Faced with the need to balance all these conflicting factors, he could be forgiven for standing up on Budget day, announcing that he had no changes to make, and sitting down again. That, however, is perhaps the only thing that we can guarantee he will not do.
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