Of all the uncertainties caused by the Covid-19 pandemic, one thing feels beyond doubt — at some point, taxes are going to have to rise.
Tackling the crisis has led to a massive surge in UK public spending. Combined with the impact the coming recession will have on tax receipts, the Financial Times estimates a budget deficit exceeding £337bn could be the result.
The chancellor Rishi Sunak faces tough choices. Increasing government borrowing could cover much of the shortfall, but the prime minister has ruled out deep cuts to public spending seen after the 2008 financial crisis. While unpopular, increasing some taxes would send a signal that ministers are getting the deficit under control.
This week, a leaked Treasury document presented a shopping list of potential tax rises to help balance the books — including increases to income tax and ending the state pension “triple lock” — that would involve breaking manifesto promises.
The predicted UK budget deficit in the current financial year
Treasury and Downing Street officials have stressed it is “too early to speculate about any future decisions” but tax experts are already predicting when, where and by how much different taxes could rise.
“Tax rises are inevitable, but the government is under pressure to kick-start the economic recovery and protect jobs so it won’t want to increase the tax load on businesses,” says Nimesh Shah, partner at Blick Rothenberg, a tax advisory firm.
Experts believe the burden is more likely to fall on wealthy individuals — as well as providing the chancellor with a historic opportunity to reform areas of the UK tax system that have proved too problematic for many of his predecessors.
Here, FT Money assesses the choices the chancellor faces ahead of the autumn Budget, including calls for a new wealth tax and a shake-up of how the self-employed are taxed — plus the tax breaks he could remove, including those on pensions and property.
Raising income tax would be the quickest and most far-reaching way of raising revenue — it accounts for nearly one quarter of total tax receipts — but it would also be politically controversial.
The Conservatives manifesto pledged the party would “not raise rates of income tax, national insurance or VAT” — the three biggest contributors of tax revenue — but experts feel the public would be forgiving if these were broken.
“All bets are off with things like manifesto pledges and triple locks — the world has changed to such a degree,” warns Mike Hodges, partner at accountancy firm Saffery Champness.
He says the chancellor could soften the blow by selling any increase as a time limited measure of three to five years to pay for the pandemic.
There would undoubtedly be pressure for any income tax increases to target highest earners, but calculations published by HM Revenue & Customs this month show how small income tax rises for large numbers of people stand to raise much more than bigger tax rises concentrated on the highest earners.
HMRC forecasts that a single percentage point rise in income tax would raise this figure in 2020-21
A single percentage point increase in the basic rate of income tax from 20 to 21 per cent would raise £4.7bn in 2020-21, the HMRC calculations forecast.
Increasing the higher rate from 40 to 41 per cent would lift the tax take by around £1bn, reflecting the smaller number of taxpayers in this band of earnings.
Yet an increase in the additional rate band from 45 to 46 per cent would only raise around £105m.
Mr Hodges says the figures show a broad increase for all taxpayers will be needed to raise significant funds. He speculates the chancellor could add 1 per cent for basic rate payers, scaling this up to 3 and 5 per cent for higher and additional rate payers (creating new rates of 21, 43 and 50 per cent).
An alternative approach — bending rather than breaking the manifesto pledge — would be for the chancellor to abolish the personal allowance; the £12,500 a year tax-free earnings threshold.
A lower “starting rate” of tax of 15 per cent could apply to this band of earnings — but the chancellor will be under pressure to protect the lowest earners from any tax rises.
Instead, he could target cuts at higher earners by dropping the rate at which the personal allowance starts to be restricted. At present, it is tapered away for those earning more than £100,000 per year and vanishes completely for those earning over £125,000.
Mr Shah thinks the chancellor is unlikely to plump for this as it would impact middle earners too much — particularly as child benefit also starts to be withdrawn at £50,000.
Tax experts predict that increasing national insurance contributions (NICs) could be more palatable than raising rates of income tax.
With different rates applying to bands of earnings and categories of employment, the government has long wanted to reform NICs. However, changes proposed at the 2017 Budget swiftly went into reverse following “White Van Man” protests.
Mr Shah believes the chancellor will consider scrapping the NICs upper earnings limit, a big hit for higher earners.
At present, employees pay 12 per cent NICs on the slice of earnings between £9,501 and £50,000, but just 2 per cent on income above this level.
Mr Shah calculates that if a flat rate of 12 per cent NICs was introduced, someone earning £100,000 would see a £5,000 reduction in their net annual pay — even if income tax rates were left unchanged.
Mr Shah also wonders if the chancellor could be tempted to go further and harmonise the NICs starting threshold with the £12,500 personal allowance. “This would be a tax giveaway for the lowest earners, but he would get that back and then some by increasing the rate for those earning above £50,000,” he says.
Mr Hodges also would not be surprised to see NICs introduced for working people over state pension age.
“The government may consider this a relatively uncontroversial tax, as NICs go towards funding the individual’s entitlement to state pensions, so could be seen as swings and roundabouts for people of pensionable age who are continuing to earn a salary,” he says.
The chancellor put the UK’s 5m self-employed on watch for increased NICs in April as a quid pro quo for launching the self-employment income support scheme (SEISS).
Self-employed people earning more than £9,501 a year pay Class 4 NICs at 9 per cent. In contrast, the main rate employees pay is 12 per cent — an inconsistency that Mr Sunak said was “now much harder to justify”.
“If we all want to benefit equally from state support, we must all pay in equally in future,” he said.
George Bull of RSM, an advisory firm, believes equalising the rate by increasing self-employed NICs to 12 per cent is “inevitable”. However, some think the government will go even further.
As employers also pay NICs for staff on their payroll, the Institute for Fiscal Studies has argued that self-employed NICs should be aligned with the combined rate of employee and employer NICs.
Such a radical move would be hugely unpopular, but the IFS argues that employer NICs significantly affect the cost of hiring staff, which discourages employment.
Pre-crisis attempts to reform taxation of the self-employed — including changes to IR35 legislation — have been put on hold, although the government has promised to return to the issue.
“We would welcome a thorough review of the whole self-employed tax system, as it’s currently a mess,” says Andy Chamberlain, director of policy at the Association of Independent Professionals and the Self-Employed (IPSE), a lobby group for freelancers. “My fear is [all the chancellor will do is say] ‘we’re going to single some people out for a tax hike’.”
Even before the pandemic, pensions tax relief for higher earners was under threat. It cost £38bn in 2018-19 making it the most expensive tax break, according to the National Audit Office (NAO).
Restricting tax relief on all pension contributions to the basic rate of 20 per cent has previously been estimated to raise more than £10bn per year.
Mr Bull thinks the chancellor will have a “once in a lifetime opportunity” to cut the relief for higher earners at the autumn Budget.
“What might have seemed like a nuclear option 12 months ago might not seem like that now,” he adds.
The amount that pensions tax relief for higher earners cost the Treasury in 2018-19
Although this would hit traditional Tory voters, cutting pension perks for the wealthy is unlikely to elicit much public sympathy at a time when so many have suffered economically and personally, adds Mr Hodges.
John Cullinane, tax policy director at the Chartered Institute of Taxation, says that in time the chancellor could go further and revisit plans to make pensions more like Individual Savings Accounts, which are funded from taxed income but are withdrawn tax-free.
A harder political decision will be whether to end the “triple lock” on annual increases to the state pension, which are guaranteed to be the higher of inflation, earnings growth or 2.5 per cent.
With inflation and wage growth likely to remain in the doldrums for some time, experts believe the 2.5 per cent figure will have to come down — which could produce annual savings of £8bn, according to the leaked Treasury document.
Inheritance tax is has been identified as ripe for reform by various bodies including the Office of Tax Simplification, giving the chancellor plenty of scope to make changes.
IHT is not the highest yielding tax, bringing in about £5.4bn a year. Therefore, the government may look at scrapping it and replacing it with a system where capital gains tax is levied whenever assets are transferred — either on death or in life, says Mr Cullinane. The UK previously had such a system in the 1970s and 1980s.
A quicker fix would be to align more closely the tax rates charged on gains with those charged on income, suggests Jeremy Coker, president of the Association of Taxation Technicians.
Currently, there are two different rates of capital gains tax — one for property, and one for other assets.
Basic rate taxpayers pay CGT at 10 per cent on assets apart from property, where they pay 18 per cent. Higher and additional rate taxpayers pay CGT on assets at 20 per cent, rising to 28 per cent on property. Individuals also have a CGT allowance, which is currently £12,300.
By contrast, income for the same groups is taxed at 20, 40 or 45 per cent above the personal allowance of £12,500.
Mr Shah also thinks it is highly likely the CGT rate will increase — possibly to a flat rate of 28 per cent — and predicts the CGT annual exemption could also be abolished for higher and additional rate taxpayers.
After pensions tax relief, the Exchequer’s second most costly giveaway is Private Residence Relief which exempts people from paying tax on gains when they sell their main home. The NAO found the relief was worth £26.7bn in 2018-19 — but changing such a longstanding feature of the UK tax system would be hugely controversial.
Nevertheless, some tax experts think there is a risk the relief could be restricted or even abolished — especially as the government has already started chipping away at it.
From April, it halved the time people can receive CGT relief after moving out of their property (known as the final period exemption) from 18 to 9 months.
As part of wider IHT reforms, Mr Shah thinks there is a possibility that the chancellor could go further by introducing a cap on the relief during a person’s lifetime or on each sale.
“It was strongly rumoured at Philip Hammond’s first Budget that private residence relief could be capped at £225,000 per transaction, meaning those making significant gains would be subject to capital gains tax at 28 per cent,” he recalls.
However, others believe that the chancellor will be under pressure to avoid any changes to property taxes for fear these could negatively affect transaction levels and house prices. Squeezing more from buy-to-let investors will also be tricky.
“The minute there’s a property crash, we have negative equity and all sorts of issues,” warns Mr Hodges.
The desire to protect the property market could even lead to tax cuts at the next Budget, Mr Shah predicts.
“The government desperately needs to get the housing market moving,” he says. “We could see a stamp duty land tax reduction for transactions below £750,000 but increases above that level, but the silver bullet would be to abolish the additional 3 per cent SDLT surcharge for second property purchases.”
Finally, a long-overdue revaluation of council tax bands is another nettle the government could grasp in an attempt to boost the coffers of overstretched local authorities — although Mr Bull says it would take a “brave” chancellor to do so.
None of the options on this unpalatable menu will come naturally to a Conservative government. Yet the scale of the economic problems faced means that proposals once dismissed as inconceivable are rapidly moving into the realm of the plausible.
Could a ‘wealth tax’ become reality?
Introducing a new wealth tax, either as a one-off or an ongoing levy on people’s assets, is another option the chancellor may consider, despite it being a policy the Conservatives have traditionally rejected.
Nick O’Donovan, senior lecturer in the Future Economies Research Centre at Manchester Metropolitan University, argues a one-off windfall tax makes ethical and financial sense as it would raise money from current rather than future taxpayers.
“If the costs of the crisis are added to the public debt, to be serviced out of conventional future tax revenues, we are essentially saying that those who engage in economic activity after the crisis should pay for the emergency healthcare spending and economic bailout enjoyed by taxpayers today,” he says.
He calculates a one-off levy of two per cent on UK households’ net wealth, calculated at around £15tn, would raise £300bn to cover the cost of the crisis. This could be levied on property net of outstanding mortgages, financial assets, businesses, savings and even pensions, he suggests.
Mr Cullinane agrees that a one-off wealth tax could “have a lot going for it”, adding that similar policies were brought in by some European countries after the second world war. Today, technology and increased sharing of data by different countries would make it easier for HMRC to enforce the policy.
“However, it would require international co-operation to stop people shifting their domicile — and international co-operation seems to be in short supply,” he adds.
There would also be the issue of people who are asset rich but cash poor, as well as the difficulties associated with valuing some assets — both of which could lead to complex disputes.
The practical factors around collection will be a concern for government, which wants money in the coffers as soon as possible, says Mr Shah. He believes the government might find introducing a new “NHS surcharge” more politically and practically attractive. The surcharge could be set at a rate of between 1 to 5 per cent.
“Given the recent public sentiment towards the NHS, a completely new and additional NHS surcharge could be introduced, applying to all income and capital gains,” Mr Shah says. “The majority of the British public would accept a universal increase to income tax and NICs to cover the cost of the Covid-19 package of measures and support future economic recovery. However, it is likely that the government would weight increases at the higher end of earnings.”