The Chancellor has made it plain that we can expect to receive tax increases in the Budget but what will they be? Jonquil Lowe, Senior Lecturer in Economics and Personal Finance, speculates on where we can expect the squeeze and says tax reform may be a driver.
We have been primed to expect tax increases in the Labour government’s first Budget on 30 October but as it’s Manifesto ruled out increasing taxes on working people it has left itself with some tough choices.
That Manifesto means it is unlikely to touch National Insurance, the basic, higher or additional rates of income tax, and VAT – but these are the biggest money-raisers since they deliver 59% of government revenue.
So where does the Chancellor go? My thoughts are that Rachel Reeves may address some of the anomalies in the tax system as well as simply raising money. Here’s what we could see:
Reduction in tax relief on pension savings
There could be a plausible rationale for reducing tax relief on pension savings, which (net of tax on pensions) cost the Treasury £53 billion in 2023-24.
Contributions made by savers and their employers are exempted from income tax and National Insurance Contributions (NICs).
In addition, savings build up tax-free and a quarter of them may be drawn out as a tax-free lump sum, or a series of tax-free sums.
But the majority of people who benefit from the relief are actually higher-rate and additional-rate taxpayers – that’s about 63% who could, arguably, afford to save without a government top up.
These reliefs were first introduced in 1921 to eradicate poverty in old age and encourage saving. Yet research suggests that rather than stimulating new saving for retirement, the tax reliefs merely encourage savers to switch existing savings into the favourable tax shelter of pension schemes.
Results of removing the employers’ NIC exemption
Removing the NICs exemption for employers on the contributions they pay towards their employees’ pensions could raise about £10 billion.
Even though the government and local authorities are major employers and would themselves have to pay a large chunk of the rise in employer NICs, the sum is still significant.
While it would not directly affect savers (i.e. voters) the downside is employer NICs are basically a tax on jobs so raising them could reduce future wages, number of jobs or both.
Lump-sum pension withdrawals
Other whispered changes are to reduce the amount of pension savings drawn as a tax-free lump sum.
While pension schemes provide an income in retirement the tax-free lump sum is an accident of the way pension laws evolved in the past.
Although there are ways to convert the lump sum into income, most savers draw it to spend making it harder, and more expensive, to achieve an adequate level of retirement income.
As far back as 1954, the Millard Tucker committee recognised the lump sum as an anomaly and was criticised for recommending it be left in place only on the weak grounds that it had become established practice.
Anomalies in the tax system and Capital Gains Tax
Another major anomaly in the tax system is the way wealth is taxed more lightly than income. By definition, this skews the tax system favourably towards the wealthy.
For example, if someone sells a financial asset, such as shares in a company, they may have to pay capital gains tax (CGT) on any profit they make.
CGT would be charged at 10% or 20%, compared with equivalent rates on income of 20% or 40%-45%, respectively. Higher CGT rates of 18% and 24% apply to profits from residential property, though your only, or main home is tax-free.
So, there is a case for raising the CGT rates for a financial assets and residential property to a level closer to those charged on income. But this might raise relatively small sums.
CGT currently accounts for just 1.3% of government revenue. The government estimates that increasing the higher rate of CGT from 20% to 21% on financial assets and 24% to 25% on property might bring in around £110 million extra a year.
But a larger increase could actually reduce the tax take because of behavioural effects, such as depressing property transactions and thus the take from stamp duty.
Changes to other ‘wealth taxes’
Two other wealth taxes that could be changed in the Budget are inheritance tax and council tax.
When inheritance tax was introduced by a Labour government in 1974, it was intended to be a tax on lifetime transfers of wealth as well as transfers on death.
Reforms by a Conservative government in 1986 resulted in today’s system under which most lifetime gifts are tax-free and, even on death, only one estate in 23 pays the tax.
As a result, inheritance tax contributes only 0.7% of government revenue and there is plenty of scope to increase that by axing or reducing some of the reliefs.
The Chancellor might also respond to local authority calls to remove the current cap on council tax rises (currently 5% unless a larger increase is approved by a local referendum).
Local councils are also calling for the freedom to vary the single-occupant discount, which currently reduces council tax by 25%.
Although such moves would be unpopular, they could help towards stemming cutbacks in local services that tend to be used more heavily by lower, rather than higher-income households.
