What will be in the Budget on 22 November?

Philip Hammond will present his second Budget on 22 November. What principles will guide his decisions, and what tax measures will be the result?

Eliminating the deficit
All Chancellors must balance their Budget. Fortunately, this is not as difficult as it sounds; it merely means that expenditure must be matched by a combination of income and borrowing. Or, to put it another way, if expenditure exceeds tax income the Chancellor must borrow the difference.

George Osborne, Mr Hammond’s predecessor, set a high priority on the elimination of this deficit. Though he did not reach this target he made significant progress towards it. When Mr Osborne left 11 Downing Street interest in the deficit waned and it largely disappeared from political discourse in the UK. The General Election of 8 June 2017 was fought with barely a reference to it. This was fortunate for Mr Hammond, because the Institute for Fiscal Studies recently stated that ‘it looks increasingly unlikely that the ever-receding target to get rid of the deficit altogether will be achieved by the mid-2020s, which is when that is currently supposed to happen’.

He is doubly fortunate in that this new lack of concern about the deficit has coincided with a consensus that pay restraint in the public sector must be relaxed and that more money must be spent on the National Health Service and on social care. Thus even if the deficit had still been a major preoccupation of commentators he might have been forced to increase it. As it is, he may be in a position to do so without coming under significant criticism, particularly if his spending plans are couched in terms of ‘investment’ rather than ‘expenditure’.

Given that none of the political parties currently in opposition are advocating austerity, there is a limit to how vociferously they can criticise any such fiscal relaxation.

Some press reports have suggested that the Chancellor may introduce a ‘Budget for youth’, whether for economic or political reasons. What is envisaged are measures such as national insurance exemptions for the under 25s or help to first-time home buyers. Ironically, any such tax reductions or specific expenditure measures can only serve to increase the deficit, thus storing up a debt to be paid by future generations, which can only mean those who are young now, their children or their children’s children.

Raising income tax or VAT rates
Nevertheless, if Mr Hammond does indeed increase expenditure he will no doubt be pleased to cover some of it by increasing taxation rather than by borrowing, to the extent that this is politically possible.

This inevitably creates problems for the Chancellor of a party whose last manifesto indicated that ‘the Conservatives will always be the party that keeps tax as low as possible’. The most straightforward way to raise a significant sum would be to increase the basic rate of income tax or the rate of VAT. The Conservative Party’s 2015 General Election manifesto contained a commitment not to increase those rates, which was given legislative force by sections 1 and 2 of the Finance (No 2) Act 2015. However, the 2017 manifesto contained no such promise and the 2015 legislative provisions were expressed to continue in force only until the next general election, which is now past.

Nevertheless, an increase in the basic rate or the rate of VAT might well be thought politically unacceptable. Increases in the 40% or 45% rates of income tax are likely to encounter less opposition, but the 40% higher rate applies to many middle-income taxpayers who might be seen as the natural constituency of the Conservative Party, and an increase would accentuate the already significant gap between the basic and higher rates. Indeed, in the longer term there is a good case for smoothing that progression by introducing some intermediate rates. That leaves the 45% rate. Since this was reduced from 50% in 2013 there have been many voices advocating that the change should be reversed. The problem, of course, is that there is a limited number of taxpayers in this top-rate band, and they are more likely to be able to control the amount of their taxable income than those in lower bands (for example, by restricting salary payments from owner-managed businesses). A 50% rate might therefore not raise as much as hoped.

The personal allowance
The personal allowance has been increased significantly in recent years and now has a statutory link to the national minimum wage (which can, of course, be overridden by Parliament). In addition, the 2017 Conservative manifesto repeated the 2015 promise that the allowance would be raised to £12,500 by 2020. For a government that wished to reduce the tax burden on the less well off, there might have been a good case for introducing a lower rate on the first tranche of income (though admittedly this has cause political difficulties in the past) rather than seeking to take large numbers of working people outside the tax net altogether by increasing the personal allowance. Arguably, keeping people within the tax charge, but at a lower rate, would do more to encourage a feeling of engagement in the democratic process, on the basis of ‘no representation without taxation’.

However, it would be a brave Chancellor indeed who would now reduce the personal allowance; the most that Mr Hammond could do would probably be to limit any increase in the allowance between now and 2020 to the manifesto commitment, and to defer as much of the increase as possible until 2020/21.

Changes to the structure of income tax
This lack of room for manoeuvre doubtless gave rise to the changes to the taxation of company dividends from April 2016, which considerably reduced the extent to which the tax system recognised that the income represented by dividends has already been taxed in the hands of the company. These changes were forecast to raise nearly £7 bn over the first five years of their implementation but because their effect was not widely understood they had little political impact. This was equally the case when it was announced that the dividend allowance of £5,000 was to be reduced to £2,000 with effect from 6 April 2018. It remains to be seen whether the Chancellor, or his officials, can discover any other similar area of the tax system where low profile changes can produce significant revenue in this way.

Capital gains tax
Capital gains tax (CGT), at rates of 10% and 20% for most assets, is at historically low levels, and the Chancellor might consider making changes in this area, of which the most drastic would be to tax gains at income tax rates, as the top slice of income. Such a system would, however, fail to take into account, first, the fact that a significant part of any gain may be a result of inflation rather than of a real increase in the value of the asset concerned and, secondly, the fact that the ‘bunching’ into one year of a gain that has accrued over many years may push the taxpayer into higher rates of tax.

Even if the Chancellor was prepared to move to a situation that many would regard as inequitable, he would need to bear in mind that the yield from CGT is limited (around 1% of total tax receipts) and that any change might have significant behavioural effects, encouraging owners of assets to retain them in the hope that the changes would one day be reversed - with the result that the tax yield would not be increased by nearly as much as expected.

National insurance
In the past, Chancellors have often favoured increases in national insurance contributions (NIC) over income tax rises, because they are less visible to those who pay them and an increase in the burden can be imposed either by a change of rates or by a change in the bands to which the rates apply. The Conservative manifesto in 2015 included a commitment not to increase the national insurance burden, but the Act that implemented this referred only to Class 1 contributions (for employees). In his March 2017 Budget Mr Hammond proposed to increase the Class 4 charge on the self-employed, arguing that the lower charge as compared to employees was no longer justified in view of increased benefit entitlements for the self-employed. Objections from within his own party, on the basis that it was a breach of the manifesto commitment, forced him to reverse this decision. For the forthcoming Budget he is not constrained by the 2017 manifesto, which was silent on this point, and presumably the case for the change in principle as regards Class 4 contributions is as cogent now as it was in March. Nevertheless, the March controversy was no doubt a bruising political experience and he may not wish to risk a repeat performance.

If he wishes to increase Class 1 contributions he is constrained neither by the 2017 manifesto nor by the legislation (which expired at the last general election). Nevertheless such a decision is unlikely to be popular.

Corporation tax
The rate of corporation tax is now at an all-time low of 19%, which is set to reduce to 17% in 2020. However, the effective rate of tax on accounting profits varies widely depending on the market sector and the size of the company. Thus a large company investing heavily in industrial buildings, on which no capital allowances are available, will have a much higher effective rate than a small company investing heavily in plant and machinery covered by the 100% annual investment allowance.

The low rate of corporation tax is intended to make the UK an attractive place for companies to do business. However, there must be a significant ‘deadweight’ cost in providing this benefit to companies that would not in any case have considered moving their activities abroad. It might perhaps be argued that once a 20% rate is reached any further reduction is subject to the law of diminishing returns. The Chancellor can hardly reverse the direction now, but it would perhaps not be surprising if he decided not to implement the forthcoming cut to 17%. On the other hand, this would not help him immediately in the task of raising revenue, because the cut is not due to come into effect until 2020.

Other matters
The Government recently published a consultation document on ‘Financing growth in innovative firms’ as part of its ‘Patient capital review’. Among other matters, this examined the role of tax reliefs in attracting funds for small companies, and considered the impact of a range of reliefs such as the Enterprise Investment Scheme, the Seed Enterprise Investment Scheme, Venture Capital Trusts, Social Investment Tax Relief, CGT Entrepreneurs’ Relief and Investors’ Relief, and Business Property Relief for inheritance tax. No specific proposals were made, but the document acknowledged that in some cases tax relief was ‘wasted’ because it was provided for investments that would have been made in any case, and in other cases relief was given for investment in lower-risk, asset-backed companies. It would therefore not be surprising if the Chancellor brought forward proposals designed to focus tax relief more closely on innovative companies. Currently tax benefits for small companies must be designed to comply with the EU’s State Aid rules, but once the UK has left the EU it may be expected to have more flexibility in this area (subject to the detailed terms of exit that are agreed).

Previous governments have tended to increase fuel duties in line with inflation or have, indeed, imposed a fuel duty ‘escalator’, increasing the rate above inflation and justifying this by reference to the environmental impact of fuel use. Since 2011 the duty has been frozen but clearly this position cannot be maintained indefinitely. Perhaps Mr Hammond will look here for some help with his budgetary arithmetic; he might perhaps justify it by reference to the fact that the cost of motoring falls in real terms as cars become more fuel-efficient.

Every year sees calls for reductions in stamp duty land tax (SDLT). There is very little conceptual justification for this charge, which is a tax on mobility rather than on income or wealth. Nevertheless, in 2015/16 it raised £10 bn for the Exchequer, and the Chancellor is perhaps unlikely to look favourably on what would be seen as a ‘tax break’ for purchasers of high value houses, however arbitrary the incidence of the tax may be.

A conclusion
There appears to be no obvious route for the Chancellor to take to raise revenue, though he may surprise us as many Chancellors have done in the past. If he has to fall back on borrowing he may perhaps comfort himself with Oscar Wilde’s words:

“One must have some sort of occupation nowadays. If I hadn’t my debts I shouldn’t have anything to think about.”
 

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Chuni Nathwani

Explained so well in great detail.
Good reading for business executives