Budget 2018 – A consideration of the Chancellor’s options

Moore Stephens’ analysis ‘Budget 2018: the fiscal landscape’, click here, examines the economic background against which the Chancellor will be deciding on tax changes for inclusion in the Budget on 29 October. The present document considers some of the possibilities and the factors that are likely to affect the Chancellor’s decisions, whether for or against.

Rates of income tax and VAT

Cuts of even one percentage point in the basic rate of income tax or the VAT rate would probably be seen as prohibitively expensive. It is true that tax rates need not necessarily be expressed in whole numbers. The VAT rate has twice stood at 17.5%; and the standard rate of income tax in 1966/67, for example, was 41.25% (8 shillings and 3 pence in the pound). Nevertheless, to reduce the income tax basic rate to 19.5% or 19.8% might perhaps suggest an element of desperation by a Chancellor determined to win a place in the history books as the architect of the lowest basic rate ever.

An increased personal allowance or a reduced ‘starting rate’
Above-inflation increases in the income tax personal allowance are a straightforward way to deliver tax reductions to the vast majority of the population (excluding only those with incomes in excess of £100,000 pa, from whom the personal allowance is progressively withdrawn). The Conservative manifesto for the 2017 General Election committed to increase the personal allowance to £12,500, and to raise the higher-rate threshold to £50,000, by 2020 [1] . The Chancellor will presumably want to devote any available funds towards achieving this aim before looking for any other ways to cut taxes.

Announcements of an increase in the personal allowance are normally accompanied by an indication of the number of individuals who will be taken out of the scope of income tax altogether as a result, and this is generally assumed to be a good thing. It might however be argued that in an ideal system the position of the less well-off would be recognised by means of a lower ‘starting’ rate rather than the complete exemption offered by a high personal allowance. If the funds available were used to finance a starting rate rather than an increase in the personal allowance this would enable more individuals to have their liability reduced (but not eliminated) at the same cost. There is also an argument (perhaps a more tenuous one) that this would encourage a greater sense of social cohesion by involvement in the political and economic process (‘no representation without taxation’). This was one of the principles of Mrs Thatcher’s ill-fated ‘community charge’ (or ‘poll tax’) that applied in England from 1990 [2] to 1993; that there should be very significant discounts for those on lower incomes, but that nobody should pay nothing at all. Whatever the theoretical merits of this position, it must be conceded that it did not gain wide support. In addition, starting rates add to the complexity of the system and have a chequered history. In 1999 Gordon Brown introduced a starting rate of 10%, but he withdrew it amid controversy in 2008.

Tax cuts for the rich

Reducing tax for higher income groups always 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 the rates, or even to adjust the thresholds to take account of 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).

Currently, as indicated above, those on the highest incomes do not have the benefit of any personal allowance, because this is progressively withdrawn where income exceeds £100,000. There has been no change to this threshold since it was introduced in 2010/11.

Even supposing that it wished to address these issues, a government with as precarious a hold on power as the present one is unlikely to risk giving the Opposition the opportunity to accuse it of favouring the rich above the ‘working families’ who form the core of the voting public. In addition, the government need not waste resources courting the votes of the wealthy because to the extent that political support is based on self-interest (which we must acknowledge is not always the case) there is little risk that the rich will transfer their allegiance to a Labour Opposition committed to the redistribution of wealth.

Once an individual’s income exceeds the current relatively low figure of £46,350 the taxpayer’s marginal rate doubles from 20% to 40%. This wide gap between the basic and higher rates has developed over many years as the basic rate has fallen and (perhaps for political reasons) the higher rate has stayed the same. Arguably there is a case for a much more gradual increase, with a multiplicity of rate-bands. However, a government with a tenuous hold on power and a great deal else to think about is most unlikely to address structural issues of this sort in the Budget.

There is a highly anomalous effective marginal income tax rate of 60% that applies to taxable income between £100,000 and £123,700 because of the effect of the tapered withdrawal of personal allowances for taxpayers with income over £100,000. In the nature of the case, if taxpayers are going to be affected by this rate at all, it will often be in their last few years at work, when they are at their peak earning capacity, and when earnings and pensions may overlap for a short period (because of fixed dates for the payment of pensions in older schemes). 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%. Again, however, the Government is unlikely to choose the present time to express its sympathy for the plight of taxpayers with incomes over £100,000.

The taxation of dividends

In 2016 the system for taxing dividends was changed dramatically. Dividends that were previously completely exempt from tax in the hands of basic-rate taxpayers are now taxable at 7.5% to the extent that they exceed a dividend allowance of £2,000. Much of the commentary on this measure has concentrated on the change in the balance of advantage for an owner manager between drawing funds from his or her company in the form of salary or dividends. However, the change also makes a significant difference to the position of a non-working (usually elderly) basic-rate taxpayer whose income, perhaps for historical reasons, mainly takes the form of dividends from quoted companies rather than of a pension.

In 2018 the dividend allowance, initially set at £5,000, was reduced to £2,000, further disadvantaging this group of vulnerable taxpayers. If the Chancellor has funds available for modest reductions in the tax burden, he might consider restoring the £5,000 allowance. However, politicians, like most of mankind, are reluctant to admit to having been wrong; and if one implements a policy and then reverses it, it is difficult to avoid the implication that one has made at least one mistake, and possibly two.

Corporation tax

In 2016, the Government declared its intention of reducing the rate of corporation tax to 17% in 2020. The 2017 Conservative manifesto indicated that ‘we will stick to that plan, because it will help to bring huge investment and many thousands of jobs to the UK’. Arguably, once the rate reached 20% there was little need or pressure for further reductions, but the government is unlikely to abandon its plan now, given that this would involve the breach of a manifesto commitment and, by implication, an admission that it was wrong in its fundamental belief that lower corporate tax rates stimulate the economy.

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 report for the EU Commission in 2014 calculated an effective tax rate of 31.6% in the UK for investment in industrial buildings, compared to 19.6% for investment in intangibles and 20.5% for investment in financial assets. For industrial buildings this is the third highest rate in the EU, and compares to an EU average of 22.5%. By contrast, for investment in intangibles, machinery, financial assets and inventories the UK is not far from the EU average [3].

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.

Tax avoidance

The present Government and the previous Conservative-led coalition government have a good claim to have done more than any previous administration to reduce the tax lost as a result of evasion or avoidance, but arguably Conservative governments are always slightly on the defensive in such debates because of the traditional association of the Conservative party with business interests. In his Budget the Chancellor may well want to announce some further initiative in this area to take the wind out of the sails of the Opposition, but the measures introduced in recent years have been so extensive that it is difficult to see quite what options are left to him.

In his conference speech he said: "We … have led the debate on reforming the international tax system for the digital economy… insisting that the global internet giants must contribute fairly to funding our public services. And let me be clear today. The best way to tax international companies is through international agreements, but the time for talking is coming to an end and the stalling has to stop. If we cannot reach agreement the UK will go it alone with a 'Digital Services Tax' of its own."

This is certainly a clear commitment, but the phrase "if we cannot reach agreement" perhaps suggests a willingness to pursue the route of international agreement for a little while longer, rather than closing off the debate in a Budget that will take place less than a month after his conference speech. On the other hand, it is nearly a year since the Government issued its November 2017 position paper on ‘Corporate tax and the digital economy’ which proposed, in default of international agreement, a tax on the revenues that businesses generate from the provision of digital services to the UK market. If this is not an idea whose time has come, it is certainly an idea whose time is not all that far away.

The predictable surprise

Surprises are such a consistent feature of Budget speeches that their occurrence (though not their nature) is entirely predictable. No doubt Mr Hammond will remain true to form in this respect. But, if we wait long enough, perhaps the surprise will be that there is no surprise. For many years commentators have expected a quiet Budget and been wrong. Perhaps this is the year in which they will be right.


[1] Forward Together: the Conservative Manifesto’ at https://www.conservatives.com/manifesto.
[2] 1989 in Scotland. Not at all in Northern Ireland.
[3] Centre for European Economic Research, Project for the EU Commission, TAXUD/2013/CC/120, Final Report 2014 ‘Effective tax levels using the Devereux/Griffith methodology’, here, table on page 2.


 

Leave a comment

 Security code