Autumn Budget: A Licence to Tax? Autumn Budget: A Licence to Tax?

If there is one good thing that has come out of the pandemic it is that we are seeing interesting debates on the fundamental principles of our tax system; the what, the who and the how of taxation. 

Reports have been commissioned into whether capital gains tax rates should be more closely aligned with income tax rates and whether it is time for a wealth tax to be introduced.  Windfall taxes have been suggested to specifically target those businesses that are seen to have benefitted during the pandemic (or more recently from the increase in gas prices). The recently announced Health and Social Care Levy resulted in numerous headlines about whether national insurance was the right vehicle for the increase. 

These debates are healthy, they focus much-needed attention on some of the distortions in our tax system and help identify areas that need reform.    

There is also a growing consensus, or perhaps acceptance, that taxes will have to rise to fund post-pandemic public spending.  Some of the public spending needs, such as social care, existed before the pandemic but the last 18 months have put them in the spotlight.

It would be easy to assume that the Chancellor has a fairly free Licence to Tax, but the response to the Health and Social Care Levy shows that, despite the widely acknowledged need for additional spend in this area, there are no easy conversations when it comes to tax increases. The Chancellor has to perfect the art of plucking the goose in such a way as to minimise the amount of hissing.

In the run-up to the Autumn Budget it is worthwhile spending some time considering where he could seek to raise more tax and, perhaps more importantly, where he will choose not to.

Two meaty tax rises have already been announced during 2021.

In the Spring Budget the Chancellor announced an increase in the headline rate of corporation tax to 25 percent effective in 2023 alongside a super-deduction designed to encourage investment before the rise kicks in. The increase is projected to bring in additional revenues of £11.9 billion in 2023-24, rising to £17.2 billion in 2025-26. 

Businesses are already considering the impact of this proposed tax rise on their forecasts and business models, and the Health and Social Care Levy will have added to this headache by imposing a further 1.25 percent on salary costs.

Larger businesses are also very much focussed on changes in the pipeline due to the OECD’s ongoing BEPS 2.0 project. As part of this project a portion of profits above a certain threshold of the largest global businesses will be reallocated to user or market jurisdictions. The proposals also introduce a global minimum tax. The timetable for implementation is ambitious and businesses are already modelling the impact and working out what systems changes will be required. The implementation and bedding in of the final measures will take several years during which businesses will face significant disruption. 

The spectre of more tax rises in the Budget may feel like the final straw and businesses will be hoping for a quiet budget with no further tax rises.

At the same time, the recently announced Health and Social Care Levy is expected to bring in approximately £12 billion a year by adding 1.25 percent to national insurance contributions for the self-employed, the employed and employers. In an environment of increasing pressure on household finances with the scheduled removal of the universal credit uplift, inflation expected to hit 4 percent and increasing fuel bills the Chancellor may feel like there is little capacity to tax the less well-off. Indeed at the Conservative Party conference, the Chancellor announced plans to help struggling households.

So what might the Chancellor do? Before addressing that it is worth looking at the current state of the public finances to set the context.

The last six months have been a mixed bag for the UK economy. Growth has overall been stronger than the Office for Budget Responsibility (OBR) predicted at the March Budget. GDP rose cumulatively by over 4 percent in the first half of 2021, compared with no growth expected by the OBR. But it has been a relatively front-loaded recovery as the economy reopened, with weaker performance since the summer.

Borrowing has also been weaker than the OBR predicted in March. Receipts have overshot the OBR forecast by £20 billion so far this year. With corporation tax receipts coming in stronger, it raises questions about the take-up of the super-deduction. Indeed, currently only 1 percent-2 percent of businesses say they intend to take advantage of it.

On the spending side, the number of people covered by the Coronavirus Job Retention Scheme has been lower than expected by the OBR in March. The flexibility of the UK’s labour market meant that many people on furlough have thus far been largely successful in being reabsorbed back into employment. That resulted in the furlough scheme (including support for the self-employed) costing around £7 billion less this year than was budgeted for.

Taken together, we expect a windfall of around £25 billion in 2021-22 relative to the OBR’s March projections. But beyond some potential small giveaways, we expect the overall Budget to be broadly fiscally neutral. The Health and Social Care Levy is already expected to raise the tax take as a share of GDP to its highest level since 1950, setting a high bar for more tax and spend. And with rising inflation putting extra pressure on the cost of servicing government debt, the focus may well return to balancing the books.

The Autumn Budget will give the Chancellor an opportunity to reassess the role of state in a post-pandemic economy, including setting out new rules to strengthen the UK’s fiscal prudence. These could include a commitment to balance the current budget by the third year of the forecast horizon and the underlying debt to start falling by 2024-25.

Despite the expectation of a fiscally neutral Budget, we may see the Chancellor use the Autumn Budget as an opportunity to help certain sectors return to health after the pandemic, perhaps financing the give-away with changes to capital gains tax or pensions relief (see later). 

During the pandemic the hospitality industry has benefited from a reduced VAT rate of 5 percent on supplies relating to hospitality, accommodation, and admission to certain attractions. From 1 October 2021, this rate was increased to 12.5 percent (until 31 March 2022). But the hospitality industry is still struggling, and we may see an extension to the 12.5 percent VAT rate beyond 31 March 2022.

The decline of the High Street as shoppers switched to on-line alternatives was already a concern before the pandemic.  In the run up to the March 2021 budget there were reports that the Chancellor was considering a 2 percent on-line sales tax however these proposals were later shelved until Autumn 2021.

The on-line sales tax was mooted as part of a solution to deal with the distortion that business rates cause between physical bricks-and-mortar and on-line retailers. Any on-line sales tax was therefore expected to be coupled with some form of reform or replacement to business rates. 

In the meantime, warning shots have been fired by retail organisations that such an on-line sales tax would ultimately increase consumer prices, an inflationary pressure that may not be welcomed at the moment.

As with many other proposals, plans to level the playing field between on-line retailers and physical retailers have largely been side-lined by the pandemic. At a time when there are significant pressures on household finances the Chancellor may yet decide the time is not right to push reforms through in this area, especially if he expects they will be passed to the consumer. 

As Glasgow prepares to host the COP 26 summit in November this year the Chancellor may choose to signal his support for the green agenda by introducing some changes in this area.

To date most of the UK environmental taxes have been behavioural, for example, they give enhanced capital allowances for investment in energy efficient assets or taxing the use of plastic bags. The Plastics Packaging Tax, another behavioural tax, is being introduced with effect from April 2022.

One obvious measure would be to increase fuel tax which has now been frozen for over ten years costing the Treasury an estimated £50 billion. The freezing of fuel duty seems a policy at odds with the drive towards a more green economy. However, many alternatives to petrol and diesel cars are still expensive and lack some of the infrastructure to cater for them (e.g. charging points). In this context an increase in fuel duties would likely hit those who can least afford it and would put more inflationary pressure into the economy.

The environment is an area where something big is clearly needed. In July the European Commission announced a package of carbon pricing reforms as part of its ‘Fit for 55’ package. The EU proposals have four key pillars which are to be phased in over four years, with one of the main new proposals being the introduction of a carbon border adjustment mechanism. 

We might see something similar announced in the UK although perhaps not this year. In the short term the Chancellor could consider extending the super-deduction in this area. Or perhaps we might see other green incentives sent to households or businesses from Rishi with love.

In July 2020, the Chancellor commissioned the OTS to undertake a review of Capital Gains Tax. Amongst one of the recommendations was that the government should consider more closely aligning the rates at which capital gains and income are taxed.

Currently, a basic rate taxpayer will pay 18 percent on residential property gains and 10 percent on other gains.  For a higher rate payer these amounts change to 28 percent and 20 percent respectively.

The recent Health and Social Care Levy may have fuelled this fire. The announcement has focussed minds on the fact that the levy falls on earned income and, other than dividends, does not attach to unearned income. At the same time the wealthier in society tend to earn a higher proportion of their income in the form of unearned income. 

To date the findings of the OTS report have not been actioned but increasing the rate of capital gains tax would be administratively quite easy to introduce and might provide a quantum of solace for those who are feeling particularly bruised by the Health and Social Care (HSC) Levy by ensuring the better off are being asked to contribute more.  

In his song Sam Smith says ‘I’ve been here before’ which pretty much sums up how we feel predicting, yet again, that the Autumn Budget could see changes to pensions tax relief, particularly for higher rate taxpayers.

Pensions relief costs the government approximately £40 billion a year. There are two main ways in which relief could be targeted; by changes to pensions tax relief on contributions or by changes to the lifetime allowance. 

In the March Budget the Chancellor froze the lifetime allowance at just over £1 million however there has been some speculation that this could be reduced to £800,000 to £900,000. Such a move would disincentivise pension saving as significant tax charges can arise if the lifetime allowance is breached.

A restriction in higher rate relief would generally target those earning between approximately £50,000 and £240,000. Above that level, the ability to make pensions contributions with tax relief is significantly curtailed due to the tapering off of the £40,000 annual allowance. For those at the lower end of that spectrum this could be a further squeeze in a world of increasing inflationary and cost of living pressures. The sky may not fall but it could lead some to shed tears of blood.

For the most part our expectation is that the Autumn Budget may be more about the dogs that do not bark. 

Wealth Tax

There has been much political discussion about a one-off wealth tax to help pay for COVID. Some would prefer to see a more permanent wealth tax. Introducing a wealth tax would drive at some of the issues around equity but there are very few examples of wealth taxes that work well and over the last few decades many have been abandoned. 

The UK already has two ways in which to tax assets; capital gains tax and inheritance tax. Both of these regimes are far from perfect, but it arguably makes more sense to deal with some of the flaws in those two regimes rather than introduce a third asset tax. 

The government has already discounted a one-off wealth tax so, although the conversations may well continue, we would not expect the introduction of a wealth tax during this government. But never say never (again).

Land value Tax

Similar to the wealth tax this drives at a foundational concept of whether we should tax effort or assets. The way we tax property is a bit of a muddle and is an area where there would be benefits from a wider ranging review which bring in all property taxes such as stamp duty land tax, business rates and council tax etc. At some point we anticipate some property tax reform, but the time is probably not right now as the country is emerging from the pandemic.

Skyfall Tax

There has been some discussion around whether a windfall tax could be applied to those companies that are perceived to have benefitted from the pandemic. We think this is unlikely. It is difficult to target taxes at specific companies without being discriminatory and the cost benefit analysis in terms of the administration and collection of introducing a one-off levy is unlikely to make sense. An on-line sales tax launched as part of levelling the playing field between retailers would be more likely.

The Taxation of Work

Finally, tax experts agree that the way in which the UK taxes different forms of labour causes significant distortions between the employed and the self-employed. We should look again at how we tax labour to ensure that the tax burden is shared fairly but also that the system caters for modern ways of working and is future proofed as we look towards increasing technological developments. But again, this would be a big upheaval in the tax system and we anticipate the can will be kicked down the road.

Bearing in mind the two large tax rises announced already this year and the high share of tax as a proportion of GDP, it is difficult to see any chunky tax raising measures being announced in the Autumn Budget.  There may be some attempt to help certain sectors out of the pandemic and level up the High Street along with something on the environment in the run up to COP26. Beyond this, however, the most likely areas for changes would seem to be Capital Gains Tax and pensions relief.