Our new Chancellor of the Exchequer, Rachel Reeves, recently announced that the government will have to raise taxes in the October Budget to plug the claimed £22bn “black hole” in the public finances. She has ruled out raising taxes on working people, whoever they are, as both she and her boss the Prime Minister, have consistently failed to say who they consider to be in this group.
Ms Reeves has also said that she will not raise taxes on ‘working people’; these taxes include VAT, income tax and National Insurance. So what choices is she left with?
A: Raise Capital Gains Tax (CGT)
CGT is charged on the profit made from the sale of an asset that has increased in value, such as stocks and shares not held in ISAs, second homes and art works/antiques. The tax is payable by individuals, which could be anyone in PAYE or in self-employment or possibly retirees.
The tax starts at a rate of 10% (or 18% on residential property) on gains above a de-minimis level of £3,000. It then rises to 20% on any amount above the basic tax rate, in other words if your gross earnings exceed £50,270 (or 24% on residential property).
Aligning CGT rates with income tax rates could be very attractive to our new government and would certainly raise a lot of money, without enormous opposition as the majority of people do not pay CGT. There is a downside however, as Paul Johnson, director of the Institute for Fiscal Studies (IFS), pointed out, which is that such a measure would be a disincentive to investment and would be contrary to Ms Reeves’ ambition to significantly increase economic growth in the UK.
B: Freeze allowances
The chancellor could take a leaf out of the Tories’ playbook and go for the so-called stealth tax option. This is a means of raising revenue which is not explicitly labelled as a tax, in particular tax thresholds, the amount of money you can earn before you start to pay tax.
Presently, the thresholds on income tax and NI are frozen until 2028, but Ms Reeves could extend them beyond this date. This is a tax rise by any other name because of a process called “fiscal drag”, which sees more people “dragged” into paying higher rates of tax as their wages increase.
James Smith CEO of the Resolution Foundation says that they have calculated the current freeze on personal allowances will result in £40bn of additional tax by 2028. He also commented that this would be enough to fill the “black hole”, meaning that no other taxes would need to be raised.
C: Raise Inheritance Tax (IT)
The Resolution Foundation said IT is very unpopular and there are constant calls for it to be abolished or at least cut. James Smith explained that this unpopularity even extends to groups who are most unlikely to pay it, because the general public consider IT to amount to taxing the same amount twice.
At present, IT is paid at a rate of 40%, on the part of a deceased person’s estate above £325,000, with no tax payable if the estate is valued below this threshold. It also does not apply if the estate goes to a spouse, a civil partner or a charity. Plus, if a home is part of the estate the threshold can go up to £500,000.
The Chancellor could raise the rate of IT, or possibly reduce the relief available on certain assets, such as agricultural land and pension savings, which can both be inherited tax free. James Smith believes IT should be reformed because there are all sorts of reliefs within the system that allow you to move your assets in a way that allows you to avoid paying IT. He also said that Ms Reeves will have to go further than simply curbing allowances, because at best this would only raise one or two billion.
D: A raid on pensions (the nuclear option!)
Most ‘working people’ pay into a pension and receive tax relief on their contributions up to a maximum of 100% of their annual earnings. The relief allows some of the tax taken on a person’s earnings, to be re-directed into their pension pots. Under the current system, savers receive tax relief at the same rate as their income tax; so basic rate taxpayers receive relief at 20% and higher rate taxpayers at 40 or 45%.
So, perhaps the Chancellor is considering the introduction of a flat rate of pension tax relief, perhaps as low as 20%. This could be a ‘win win’ scenario for Ms Reeves, as it would have zero impact on the majority of taxpayers but would be far less generous for higher earners and would play into the Labour Party mantra of “tax the rich”.
It is clear that this would bring in billions in additional tax for the government. The downside, however, is that this measure may dissuade people from saving for the future and might be difficult to implement.
Accountant’s view
Most economists and accountants agree that the above choices are realistically the only significant areas that could potentially raise the amount of additional tax needed to plug the ‘black hole’, without rioting in the streets.
However, the Bank of England’s rate cut last week from 5.25% to 5%, the first drop since March 2020, will mean the huge level of interest paid on the National Debt will go down and give dear Rachel a little bit of wiggle room.
