When the Chancellor, Alistair Darling gets to his feet in the House of Commons on Wednesday 24 March to present the final Budget before the next general election, he will be expected to present details on the government’s plans to square a very round circle. How to reduce a vast public borrowing deficit, already running into the sort of numbers only pure mathematicians normally deal with (£178 billion for this year), while nurturing a still fragile economic recovery.
However Mr Darling dresses his statement, it will involve spending cuts and (maybe) tax rises. True political debate will centre not on the principle of those rises and those cuts but on their timing.
One group of economists – 20 in number – expressed, in a letter to the Sunday Times, the importance of a more urgent reduction in the structural budget deficit than was set out in the pre-Budget Report of last December (Mr Darling promised a halving of the borrowing requirement in four years). No sooner was that communication received than a missive from 67 other economists landed on the desk of the Financial Times counselling the wisdom of delay: don’t slash public spending until 2011 in order to support the weak recovery of the private sector (ONS estimates of GDP growth in the final quarter of 2009 heralded the end of recession but by a feeble 0.3 per cent).
Timing; that’s the only difference. There will have to be severe fiscal tightening, sooner or even sooner. The cuts, when they come in their full pomp and from the pen of whichever Chancellor, will be probably as deep as anything seen since the 1980s.
What we think we know about the Budget
Taking the 2009 pre-Budget Report as a framework guide to the Budget itself, the Chancellor may confirm a number of measures.
One of the major announcements in Alistair Darling’s pre-Budget Report was the decision to raise employers’ and employees’ national insurance contributions. Employee, employer and self-employed NICs will rise by 0.5 per cent in April 2011 on top of the 0.5 per cent increase announced in the 2008 pre-Budget Report.
There were changes to income tax as well, although they have been deferred. The point at which taxpayers are charged the 40 per cent rate of income tax is to be frozen in 2012/13 at its 2011/12 level, which means more people will be liable.
The £325,000 threshold for the inheritance tax is to remain in place for 2010/11.
To the relief of smaller firms, the Chancellor deferred the planned rise in the rate of small companies’ corporation tax. The 1 per cent rise, from 21 to 22 per cent, has been held over for another year, remaining at 21 per cent in 2010/11.
Spending growth will slow to an average of 0.8 per cent a year between 2011 and 2015. Government contributions to public service pensions for teachers, councils, NHS and the civil service are to be capped by 2012, and all public sector pay deals are to be capped at 1 per cent for two years as from 2011.
Clues about what we don’t know
Mr Darling has acknowledged the broader direction of the forthcoming Budget, even if he has remained tight-lipped on its details. In an Edinburgh speech, the Chancellor confirmed the imminence of spending reductions and of “fair tax rises, with the biggest burden falling on those who can most afford it”.
The Chancellor is keen, it is reported, to provide more specific plans about exactly how he intends to tackle the public deficit in order to reassure the bond investors who buy the gilts that fund the government’s debt that the administration is serious about reducing its borrowing levels. In mid-February, jitters in the government debt market pushed the yield on the benchmark 10-year gilt to almost 4.1 per cent, a level that added significantly to the cost of the UK government’s borrowing.
Just how specific Mr Darling will be about his plans may be tempered by the looming general election.
One independent think tank, the Institute for Fiscal Studies, estimated as necessary a three-year purging of £36 billion from various Whitehall departments, starting in 2011. Will the Chancellor be prepared to put such an exact and high figure on the cuts?
Much has been made of the need not simply to reduce public spending but also possibly to increase taxation as a way of combating the budget deficit.
Recently, Liam Byrne, the Chief Secretary to the Treasury, ruled out further tax increases other than those already announced. Government plans to cut the current deficit by half within four years centre on reining in Whitehall spending and bulking up income with the £19 billion that the intended tax increases should deliver.
Asked in a BBC interview if additional tax increases were necessary, Mr Byrne said: “We’ve set out exactly how we will find that £19 billion, and we set that out in the pre-Budget Report.”
Mr Byrne also took the interview as an opportunity to rule out any increase in the standard rate of VAT: “We don’t see the need to do that because we’ve made some difficult decisions about National Insurance contributions.”
Later, however, Mr Byrne appeared to temper suggestions that there would be no tax rises, conceding, on VAT at least, that “Chancellors have the right to come back to tax matters at every Budget”.
The indication is that the Budget will focus on spending cuts rather than on sweeping tax rises, even though the Institute for Fiscal Studies has predicted a further £30 billion of fiscal tightening by 2017/18 on top of the plans already in place. Capital Economics, another think tank, estimated that £20 billion would eventually need to be found through tax and VAT hikes.
If big tax adjustments may seem unlikely this close to a general election, there may be some significant tweaks.
With the higher rate income tax already set to rise to 50 pence in the pound, will there be other tax measures aimed at higher earners?
Mr Darling could yet lower the threshold of the 50 per cent rate to incomes of £100,000 a year. Or he could hitch the current 40 per cent on earnings over £43,875 to a 42 per cent or 45 per cent rate. This, though, would be unpopular at election time.
There may be changes to basic rate income tax, pushing it up from 20 per cent to 22 per cent. A more possible outcome, however, would be to freeze personal allowances for several tax years – or to do on a delayed basis – in the hope that wage increases will scoop more earners into higher tax brackets.
Anti-avoidance will probably loom large. There is a 32 per cent difference between income tax rates, at the higher level, and capital gains tax. The temptation for some taxpayers is to transform income into capital as a way of sidestepping the more onerous income tax charge. The Budget may set out additional ways and means of controlling this.
Although there are pension tax relief anti-forestalling rules in place – to head off significant switching of funds to pension pots ahead of the arrival of the new, lower relief rates which will taper to as low as 20 per cent – the Chancellor may choose to amend these even further.
Salary sacrifice schemes may also come under the spotlight.
Capital gains tax
There may be leeway to increase CGT, currently at 18 per cent, to as much as 20 or 30 per cent. The Chancellor could soften the impact by raising the allowance threshold at which the charge becomes liable, perhaps to £25,000.
Although the CGT tax rate is anomalous, the Chancellor only amended it as recently as 2008 and he may not regard the returns on another change – income tax, national Insurance and VAT are much bigger earners for the government – as worth the effort.
However, he may move to push up the current flat rate of 18 per cent for those who only hold assets for a short, speculative period or as a means of re-designating income. For those who keep assets for the longer term, such as entrepreneurs with genuine investments, could be rewarded with the lower rate.
Corporation tax for larger firms is 28 per cent. The Chancellor could propose reducing this by 3 per cent but, in return, make the rules on company losses more demanding. The scope that UK companies have for carrying forward losses against future profits is a broad, effectively indefinite one, extended, as it is, until they have accrued a similar sum in profits; imposing a time limit – maybe six years – may be an option.
Any changes, though, may be unlikely, be they for large or small companies. Expect to see the small company rate pegged at 21 per cent, with the planned increase to 22 per cent postponed for another year.
The old 17.5 per cent rate of VAT returned on 1 January. But could the Chancellor actually raise VAT, perhaps to 20 per cent? Some business groups regard an extra VAT hike as preferable to the planned increase in NICs.
The Treasury may worry such a move would serve to fuel inflation, but with the Bank of England forecasting that rises in the cost of living are likely to drop back well below the government’s 2 per cent target later in the year, that concern may not weigh so heavily.
VAT is the government’s third largest source of finance. Raising VAT to 20 per cent would add a further £12 billion a year to the public coffers, the equivalent of a 3p in the pound hike in the basic rate of income tax. The EU average for VAT charges is 20 per cent.
If VAT doesn’t rise now – the recent reversion suggests it won’t – increases may become inevitable in the future in order to tackle the deficit.
National Insurance Contributions
An increase of 1 per cent is already penciled in for April 2011, so the scope for further hikes looks limited. A less high profile tax than income tax, NICs may attract attention later in this Parliament if public finances still look parlous.
First the car scrappage scheme, then the boiler scrappage scheme. Environmental taxes are a good way of introducing revenue-raising charges, so more may be on the cards.
Venture Capital Trusts
Venture capital trust tax breaks for investors seem set to remain in place.
VCTs offer private investors income, dividend and capital gains tax breaks when they put money into unquoted or Alternative Investment Market firms.
Ian Pearson, the Economic Secretary to the Treasury, has said: “This government is committed to ensuring that VCTs continue to play a positive role in encouraging investment and enterprise in the economy, and contribute to further growth and employment in UK companies.”