Economic Q&A replay: the UK tax policy outlook
Increased government spending during the coronavirus pandemic has fueled expectations of higher taxes down the road. In light of this, Investec Chief Economist Phil Shaw and Investec Wealth & Investment's Simon Bashorun examine the future of UK tax policy following the country's recent Budget and "Tax Day" in our latest webinar.
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Webinar summary: Not so taxing - "Tax Day" leaves government room for manoeuvre
With much speculation over post-pandemic tax reforms, the UK government decided to set aside a designated day, three weeks after the Spring Budget, to update its vision for the next decade of tax policy. Dubbed "Tax Day", the idea was to shine a spotlight on the subject while allowing commentators ample time to scrutinise new measures.
The move to distance a relatively benign and well-received budget, which sought to reassure by extending Covid-19 support measures, from a host of planned tax reforms left sceptics expecting the worst.
However, Investec Wealth & Investment’s Simon Bashorun said Tax Day was anti-climactic. Like the Budget, Bashorun explained that the announcements were remarkable for what they left out. Highly anticipated reforms on pensions tax relief, inheritance tax and capital gains tax were conspicuous in their absence. Instead, the government chose to focus on the modernisation of tax administration, tackling non-compliance and other tax policy announcements.
Playing it safe
After the government announced a series of supportive and nuanced measures in the Budget, Bashorun said he anticipated that Tax Day could see some significant changes. But despite multiple consultations, capital gains tax was left unchanged, as were inheritance tax and previously discussed higher taxes for the self-employed.
“While the chancellor said the level of public spending cannot continue and a series of tax rises will be needed, it did not seem to me that the measures introduced are actually going to be enough to balance the books,” Bashorun said.
Nevertheless, he welcomed the focus on modernisation, non-compliance and other tax policy announcements. The modernisation of tax administration will set about making tax digital, re-examine the timing of payments and reduce reporting requirements.
As a result, the self-employed and companies may have to pay tax more frequently throughout the year rather than all at one particular point. However, there was good news on the inheritance tax front, Bashorun said, as the roughly 200,000 non-paying estates will no longer have to go through an onerous reporting process from January 2022.
Among the announcements, Bashorun also noted a review on improving processes for individuals who overcontribute to pensions; confirmation that there is no desire for a comprehensive review of trust legislation; and the intention to make sure that owners of second homes can only register for business rates — and therefore business rates relief — if their properties are genuine holiday lets.
Overall, Bashorun said maintaining the status quo was sensible: “If the government can modernise and digitalise the tax system and efficiently collect what it is owed, when it is owed, without leakages, this could negate the need for further tax rises.” While the gap between what HMRC expects to receive and what it receives is the lowest it has been for some time, he notes this still stands at £30 billion – more than the amount the tax band freezes announced in the Budget aims to cover.
Does this mean more changes in the Autumn Budget?
We will have to wait and see, Bashorun said. He thinks we are likely to see more changes in the next six months and beyond, with Tax Day likely to become a regular feature.
He explained that the government’s approach to achieving a successful long-term recovery rests on ensuring growth and spending are robust before taxes can be re-examined.
“The chancellor has his back against a wall,” Bashorun said, “both in terms of the taxes he can change and in terms of the timing.” Also, he noted that the recent uptick in gilt yields had multiplied the cost of Covid borrowing to the extent the additional revenue from the Corporation Tax raise planned for 2023 has practically been wiped out already. “This leaves the chancellor in a tight corner.”
However, Investec Chief Economist Philip Shaw explained that the prospects for the UK economy are upbeat, with growth forecasts currently being revised upward. The Office for Budget Responsibility has recently said its estimate of £355 billion in government borrowing for 2020-2021 might be too high. Consequently, Shaw said the amount of corrective action the chancellor will need to take to get the fiscal position to a more sustainable level might be less than previously thought.
The message for savers, according to Bashorun, is to make the most of current tax rates and allowances as they may not be as generous in the future. “This is an opportunity to review our affairs, to understand the assets we have, to understand the treatment of those assets from a tax perspective, and the role they are going to play in our lives and the future of our families. Make sure you are using all the non-contentious wrappers, allowances and exemptions available now, particularly the use-it-or-lose-it ones.”
Asked what he would change about the UK tax system if he were in charge, Bashorun said: “I would overhaul the pensions tax regime. I do not believe it is currently fit for purpose.” He pointed to a lifetime allowance that is little higher than it was 15 years ago; eight forms of lifetime allowance protection; tax relief going to those who need it least while some are not getting any; as well as perceived inequalities between defined benefit and defined contribution schemes.
Shaw echoed this opinion: “As an economist, I would prefer to see a simpler and more transparent tax system, with fewer exemptions and fewer tax rates – perhaps combining income tax with national insurance.”
Spring Budget recap
“Taxation by stealth seems to be the order of the day,” said Bashorun, recalling the measures announced in the Spring Budget 2021. He noted that the Conservatives were able to stick to the letter of their manifesto by maintaining income tax, national insurance and VAT rates, while making small but significant changes elsewhere:
- Freezing the personal allowance for income tax at £12,570 and the higher rate threshold at £50,270 until 2026 will push more people over the basic 20% and higher 40% thresholds as earnings rise with inflation. This is expected to raise about £20 billion.
- Similarly, the annual exempt allowance on capital gains tax will be frozen at £12,300 until 2026 – a generous sum compared to the £2,000-£4,000 that the Office for Tax Simplification suggested would be appropriate.
- The nil-rate band for inheritance tax, which has been frozen at £325,000 since 2009, will stay at this level until 2026, while the residence nil-rate band will remain at £175,000. Although only about 5% of estates pay inheritance tax, many more will fall into this category if the value of real assets continues to rise.
- Equally, the lifetime allowance for tax relief on pension contributions will be frozen at £1,073,100 through to 2026. Bashorun takes issue with this, given the lifetime allowance was virtually the same 15 years ago, while annuity rates have effectively halved over the same period.
He said: “If you get to retirement age now and buy an index-linked annuity with your fully-funded pension up to the current lifetime allowance, you are effectively buying a starting annuity rate of less than the average UK wage. I can only hope this freeze does not last the whole six years and is an indicator that wider reform is due.”
- Corporation tax will increase, although this was kicked down the line to 2023. The announcement of a rise from 19% to 25% was also softened with a small profits exemption for companies with profits under £50,000, and a tapering of the rate for businesses with profits up to £250,000. While 70% of trading businesses will fall under the exemption, paying 19%, most investment companies will be looking at a 25% tax – a significant increase from current levels.
- While the UK still retains the lowest corporation tax rate among countries in the Group of Seven, Bashorun noted these changes would increase the UK’s corporation tax regime’s complexity. Attempts to further soften this include the delay in raising corporation tax, the ability to carry back losses from two Covid years, as well as a “super deduction”, allowing companies to cut their tax bill by 25 pence for every £1 they invest in qualifying plant and machinery.
- In other good news, the stamp duty exemption was extended through to the summer and thereafter remains at a nil-rate band of £250,000 until October.