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Analysis of UK taxation options amid Covid-19

5 minutes read
Last updated on 09th September 2020

The views and opinions expressed in this article are those of the author.

Overview

Michael Collins, Prudential Director of Government Affairs, provides an analysis of the UK taxation options amid Covid-19. 

When I worked on tax policy in the Treasury one of my colleagues once shared a quote with me about the nature of the work that we were doing:

“the art of taxation consists in so plucking the goose as to obtain the largest number of feathers with the least possible amount of hissing”

Although attributed to an ancien regime official in the court of Louis XIV the challenge that Jean-Baptise Colbert was expressing in the 17th century still confronts every Finance Minister: where do you get revenue from without causing irretrievable harm to your political popularity or without causing major distortions to the economy?

The scale of the problem in the UK

In the UK Rishi Sunak will be feeling that challenge more acutely than any Chancellor has for a generation as he steps up preparations for the expected (though not yet confirmed) autumn Budget.

With the UK’s deficit perhaps reaching 20%[1] of GDP this year and the ratio of debt to GDP now at 100%[2] the public finances are in a state that no official working in today’s Treasury has ever had to deal with.

Economists still disagree on the extent to which this is a problem as with interest rates remaining low – many governments are currently able to borrow from the markets at almost no cost – the servicing of this additional debt burden remains manageable.  And in an economy like the UK where control over monetary policy remains entirely in national hands there’s always the ultimate backstop of the Bank of England and the proverbial printing presses should things turn really sour.  (Proponents of modern monetary theory would go even further and suggest that governments and central banks can - and should -  be much more open to ‘printing money’ as a normal part of their macro-economic planning).

But while this academic debate continues the indications from his statements before the summer break are that the Chancellor remains fairly orthodox in his thinking and will be looking to bring debt down, back closer to its pre-COVID levels.

[1] https://cdn.obr.uk/OBR_FSR_July_2020.pdf

[2] https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicsectorfinance/bulletins/publicsectorfinances/june2020

Growth, austerity and tax rises

The Treasury will be hoping that economic growth will do some of the job for them. As an economy bounces back there are fewer demands on the expenditure side (e.g. from welfare payments) and more revenue as people get back to work and businesses return to profit – what are known as the ‘automatic stabilisers’.  It’s a safe assumption that the Treasury’s Budget planning (including whether to even hold a Budget this autumn) will include all sorts of scenarios for UK economic output and thus for the scale of the debt and deficit ‘hole’ that needs to be filled.

Apart from growing (or inflating!) your way out of trouble, debt and deficits can only be tackled in two ways: cut spending or raise taxes. But when growth remains fragile and may need government spending to bolster it; when unemployment is shooting up and bringing with it big increases in welfare spending; when tackling COVID19 still requires extra investment in research and new treatments; when the ‘levelling up’ agenda still needs to be delivered; and when ‘austerity’ looms over British politics as a slur, it’s hard to see Sunak forcing public spending to do most of the heavy lifting on deficit reduction.

There is a Spending Review due this autumn and some departments will surely see cuts to their budgets as part of this process.  But when the Treasury does decide to tackle the deficit (and ‘can kicking’ is still a very serious prospect) it’s safe to assume that tax increases will have a sizable role to play.

But as Colbert knew in the 17th century, it’s one thing for everyone to know that feathers need to be plucked, but some geese will still hiss and honk more than others when you come after them!

Which taxes do you increase?

In Britain in 2020 there are three main sources of tax revenue that tower over the rest: income tax and NICs; VAT; and corporation tax. It’s hard to imagine that Treasury won’t look at whether it can get more income from these tried and tested sources.  There’s always a certain amount that can be done by stealth with these taxes – not raising the income tax personal allowance, for example, is a classic tactic; or keeping the headline rate of corporation tax unchanged but tightening up or removing particular allowances or opportunities for corporate tax planning. But while in normal times these sorts of changes might have raised enough to give the Chancellor the odd billion he is looking for to bring down the deficit or to reward a worthy public sector cause, they’re not going to be sufficient to offset tens of billions (and rising each month) of extra borrowing.

Putting a penny or two on the basic rate of income tax or raising VAT from its current level has the advantage of immediately bringing in billions and of being comparatively easy to implement. But these have the political disadvantage of being highly visible, generally unpopular, and to run counter to an explicit 2019 manifesto commitment that the Conservatives made.

Taxing wealth

Are new taxes on wealth therefore the answer, as the Shadow Chancellor, Anneliese Dodds has suggested?

Certainly UK households do have significant amounts of private wealth that the Treasury might look at: over £14 trillion[3] according to the ONS.  And taxing wealth is – superficially at least – popular. A recent opinion poll that solicited views on possible new post-COVID tax measures showed over 60%[4] support in the UK for a new form of wealth tax.

The challenge though is deciding in 21st century Britain quite who is wealthy and what constitutes wealth. 

The wealth tax idea that YouGov sought views on, and that was so popular, was a levy only on an individual’s net worth over £750,000, excluding personal pension savings and the value of their main home. In other words, this support was for a tax that most voters would never expect to have to pay. And while that might make it look politically attractive (which Chancellor wouldn’t like a tax that most voters never have to pay?) it quickly leads into the next questions that wealth taxes always pose: just how much will they actually raise? And is that revenue estimate enough to justify the cost and the challenge of tax collection and the downsides of the behavioural changes they generate as people try to avoid it?

As a general rule tax administrations tend to prefer taxes – and wealth taxes would be no different - that are simple to administer, that are harder to avoid or to plan around, and that don’t distort behaviour.

The more complex the wealth tax being proposed - the more assets are excluded, the longer the lead-in time - the greater the opportunities for avoidance and planning and the greater the risk of distorting people’s behaviour. And it’s a reasonable bet that the wealthier the cohort that’s affected and the greater the amount of tax to be collected from them the greater the chance of avoidance or of behavioural changes that may be unwelcome for other reasons of public policy.

One way around the avoidance problem at least is the ‘smash-and-grab’: levying a tax with almost no prior warning on wealth that is easy to get hold of, such as cash deposits.  A recent example of this approach to wealth taxation was the 2013 levy on bank deposits in Cyprus, proposed as part of the country’s bail out agreement with the troika. With large bank withdrawals frozen by the authorities the levy was designed to be applied automatically, with sums skimmed off bank accounts at source[5], thereby minimising prospects for avoidance.

But it proved politically impossible to deliver and if a country facing a sovereign debt crisis and in need of a bail out couldn’t sell such a raid it’s hard to imagine the British Chancellor of the Exchequer getting away with a tax of that sort on liquid financial assets, even during a pandemic.  One can imagine the political and media outrage if the proceeds of a recent house sale that were needed for the next home purchase was suddenly taxed; or if a worker who had lost their job as a result of COVID19 saw a chunk of their redundancy payment suddenly taken away in tax.  And once you’re having to differentiate between ‘good’ wealth (not to be taxed) and ‘bad’ wealth (to be taxed) you are opening the door to an administrative and compliance nightmare, not least for HMRC.

[3] https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/totalwealthingreatbritain/april2016tomarch2018

[4] https://docs.cdn.yougov.com/p54plx0gh9/NEON_PostCovidPolicy_200508_w4.pdf

[5] https://www.ft.com/content/33fb34b4-8df8-11e2-9d6b-00144feabdc0

What sort of wealth?

Over three-quarters of the wealth of UK households is in private pensions and property, making these obvious places to look for additional revenues.  And there is plenty of precedent for looking at both these sources, whether that be changes to the Capital Gains Tax treatment of second homes, or the 1997 ‘raid on pensions’[6] or the constant speculation that pension tax reliefs might be for the axe.

It’s a reasonable assumption that both property and pensions would be under consideration by any government looking to raise significant sums from wealth, simply because that’s where so much wealth is concentrated. (It’s like the bank robber who when asked why he robbed banks replied “because that’s where the money is”.  If a government wants to tax wealth it’s got to look at where that wealth is held).

Another obvious place to look is inheritance, echoing the observation of the great Liberal politician David Lloyd George that “death is the most convenient time to tax rich people”.

Inheritance certainly provides a significant potential source of tax revenue – a recent IFS study[7] suggested that Generation Y may be on track to benefit from unprecedented transfers from their parents: “inherited wealth is on course to be a much more important determinant of lifetime resources for today’s young than it was for previous generations… more than one-in-ten of those born in the 1980s will receive inheritances worth in excess of half the amount of average lifetime earnings for their generation” [emphasis added]. 

And with inheritance not evenly distributed across social-economic groups (for example, the IFS find that those born in the ‘80s who graduated from university have parents with about 70% more wealth to potentially pass on than their peers who left education following their GCSEs) it would be possible to build a ‘levelling up’ argument in favour of taxing inheritance, should the Chancellor want to do so.

The Office of Tax Simplification concluded a review of IHT in 2019 and while the context in which that review was commissioned was very different it certainly sent a clear signal that the Treasury remains interested in this tax .  But recent British political history suggests that when a party proposes measures that might reduce the size of the inheritance that the next generation were expecting it does not tend to go down well – the Conservatives saw that in the 2017 election with their manifesto plan for funding social care (dubbed a ‘dementia tax’ by opponents) proving deeply unpopular and being blamed by some commentators for Theresa May’s failure to secure a majority. 

None of the options that are open to Rishi Sunak are palatable and all have political and economic downsides.  While he will be hoping that Q3 and Q4 data reduce the scale of the problem a bit it’s not going to make any appreciable dent in the stock of debt that now sits on his desk. Deciding which geese to take feathers from and how soon may well determine his – and his party’s – political future.

[6] https://www.ftadviser.com/2014/05/07/opinion/tony-hazell/savers-could-have-lost-bn-in-brown-s-pensions-raid-WTQAjLW5DSRp9HUxwNZN7K/article.html

[7] https://www.ifs.org.uk/publications/14954