What will be in the 2017 Spring Budget?

The mechanics

The Chancellor of the Exchequer, Philip Hammond, will present his first and last Spring Budget on Wednesday 8 March.

The reason that this is a ‘one-off’ occasion is not because Mr Hammond is contemplating an exit from the role of Chancellor, but because on 23 November 2016, in his first and last Autumn Statement, he announced that in future the Budget would take place in the Autumn, and the Autumn Statement (which deals primarily with spending rather than tax decisions) would be abolished.

The result is that, for 2017 only, there will be two Budgets (and no Autumn Statement). From 2018 onwards the Budget, which will take place in the Autumn, will be the only major fiscal event of the year.

The Chancellor’s priorities

While this is Mr Hammond’s first Budget, his Autumn Statement in November 2016 means that he is no longer an unknown quantity as Chancellor. Arguably, two key points emerged from that statement.

The first was that George Osborne’s target of eliminating the deficit by the end of the current Parliament in 2020 was to be abandoned. The goal now is to eliminate the deficit ‘as early as possible in the next Parliament’. 

The second point was an emphasis on the need for capital investment, particularly in infrastructure, in order to boost the UK’s relatively low productivity.

Eliminating the deficit

Deadlines for eliminating the deficit are significant politically, but perhaps less so from an economic perspective. What is more important is to see the deficit firmly established on a declining trajectory.

Nevertheless, from both a political and an economic perspective the revised target date gives Mr Hammond considerably more leeway.

Brexit

Brexit is a further issue that is likely to dominate the current Government’s time in office. However, while leaving the EU will mean more flexibility for the Chancellor in areas of the tax system where the Government is currently bound by EU rules, any resulting changes are unlikely to be seen before the terms of the UK’s exit are finalised, and even then are likely to take place gradually.

Brexit will, however, still have an impact on the Chancellor’s decisions in that, whether or not it eventually proves beneficial for the UK economically, it will inevitably give rise to a period of uncertainty, and possibly to a period of inflation resulting from the fall in the value of sterling.

The Budgetary options

Deficits can only be reduced by increasing taxes or reducing spending (or both).

Capital investment can only be boosted by direct government spending or by forgoing tax revenue and giving tax reliefs for investment by businesses.

In reaching his Budget decisions Mr Hammond therefore has to balance a number of factors. Some of them point in favour of increasing spending and some in favour of reducing it. Some of them point in favour of increasing taxes, and some in favour of reducing them by giving increased tax allowances.

The ideal, of course, is to reduce tax rates in order to stimulate the economy and end up with increased tax revenue. The problem with this strategy is that, even if it works in the long term, it is most unlikely to provide a short term fix.

After the ‘tax lock’, what is left?

It is not absolutely clear whether the Prime Minister and Chancellor consider themselves bound by the ‘tax lock’ introduced by the previous Chancellor, under which the Government was committed, broadly, not to increase headline rates of income tax and VAT. (Technically, of course, the current Government is bound by the tax lock because it was incorporated into legislation,  but it would in theory be free to repeal that legislation if it decided to implement a change of policy.)

However, the Autumn Statement recommitted the Government to increasing the income tax personal allowance to £12,500 and the higher rate threshold to £50,000  thus further reducing the Chancellor’s room for manoeuvre.

If headline rates of income tax and VAT are to stay the same under the tax lock, then the Chancellor’s scope for increasing tax revenue is severely limited. One option would be to look for possible structural changes, like George Osborne’s reform of the tax treatment of dividends. Those changes to dividend taxation will have a significant impact, being expected to raise £10 billion over a five-year period.  Arguably this comes at some cost in terms of fairness, given that the profits that are distributed will already have been taxed in the hands of the companies concerned. It is unlikely that there is another such rabbit left for Mr Hammond to draw out of the hat, but he may surprise us.

Another option is to increase some of the taxes and levies that contribute comparatively little to the Exchequer, such as landfill tax, air passenger duty and climate change levy, but which are not covered by the tax lock. Mr Hammond made a start in November with the announcement of an increase in the rate of insurance premium tax. The problem here, however, is that these taxes are simply not significant enough for increases to yield substantial revenue.

Most Shadow Chancellors indicate that if they were sitting on the other side of the House they would solve the Exchequer’s problems by clamping down on tax avoidance and tax evasion. However, George Osborne may well have run the well dry. Both under the coalition Government and the later Conservative administration he has a claim to have done more than any previous Chancellor to take effective action in this area. No doubt there is still some action left that Mr Hammond can take, but there cannot be much.

Business taxation

Historically, the current 20% headline rate of corporation tax is low. In general it makes the UK attractive to overseas investors and does not discouraging enterprise. Further reductions in the rate, to 19% and then to 17%, are already planned. Clearly companies will welcome these reductions, but it is at least arguable that they may reduce corporation tax receipts without attracting additional investment.

It must be borne in mind that the effective rate of corporation tax varies considerably between different industrial and commercial sectors. In the main this reflects the fact that while tax relief is available through the capital allowances system for expenditure on machinery and plant and intangibles, there is no relief for industrial or office buildings or hotels. Thus a recent report for the EU Commission calculates an effective tax rate of 31% in the UK for investment in industrial buildings, compared to 18.7% for investment in intangibles and 19.5% for investment in financial assets. For industrial buildings this is the second highest rate in the EU, and compares to an EU average of 22.4%. By contrast, for investment in intangibles, machinery, financial assets and inventories the UK is one or two percentage points below the EU average.

It is unlikely that any government has set out to use the tax system to discourage manufacturing industry, but this is what the tax system does. If Mr Hammond wants to encourage productivity via increased investment he could consider increasing the rates of capital allowances for plant and machinery and extending allowances to buildings, particularly industrial buildings. Similarly, if allowances were given for hotels in the UK and these fed through into lower costs this might go some way to help the UK tourist industry recover part of the domestic market.

Recent weeks have seen significant disquiet about the effect on small businesses of the business rates revaluation due to take effect from 1 April 2017. Mr Hammond has now indicated that he is in ‘listening mode’, and the Budget may well include some reduction in the burden or at least a more generous transitional relief. There has been some suggestion that this could be made revenue-neutral by increasing the burden on larger companies. There might also be proposals for longer-term reform.

Squeezing the rich?

If the Chancellor cannot bring himself to increase the basic rate of income tax he could perhaps still follow the example of one of his Labour predecessors in ‘squeezing the rich until the pips squeak’  (though, strictly, both the higher and additional rates of income tax are also covered by the tax lock). Here, the risk is that of killing the goose that lays the golden egg. Currently more than a quarter of the total of income tax is paid by the top 1% of taxpayers, while almost half the adult population pay no income tax at all.  It must be open to doubt whether more can be raised from the most well off without discouraging enterprise. Similar considerations apply to the middle earners who have increasingly been driven into the higher rates of tax as thresholds have been frozen or increases limited.

Squeezing the poor?

Some would argue that if ‘we are all in it together’ then even the lowest paid should bear some of the burden, because there should be ‘no representation without taxation’. On this view successive Chancellors have made a mistake in favouring increases in personal allowances over reductions in the basic rate (or the introduction of lower rates); they should have reduced the tax burden on lower income groups without eliminating the tax liability altogether, because this would improve social cohesion.

Whatever the theoretical merits of that argument, reversing the policy now and increasing taxes on the lowest paid might be electoral suicide. On the other hand the political impact might perhaps be limited, because few of those affected would be natural Conservative voters. Nevertheless, going down this route would probably be a ‘courageous decision’ politically, and we do not rate it as a very likely possibility.

Where does that leave us?

It appears that Mr Hammond has very little room for manoeuvre. His deferral of the date for eliminating the deficit has won him some time. Perhaps the best he can do now is sit tight and hope that a global recovery and a ‘good Brexit’ will come to the rescue.
 

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Simon H

Will be an interesting to see how the new chancellor handles
the economic straightjacket handed to him by GO post Brexit.

The Brexit effect will be a major thorn in his side to factor into the equation.

Good luck PH!