The unprecedented package of measures introduced by the UK Government to protect the economy in the wake of the Covid-19 pandemic has already cost more than £100bn. The Government is facing a potential drop in tax revenues of a similar figure - VAT receipts in March 2020 were reportedly at their lowest monthly figure since September 1992, the month following the UK’s withdrawal from the European exchange rate mechanism. As a result the UK Office for Budget Responsibility has forecast a potential budget deficit of £280bn in the 2020/2021 financial year.
As the Government starts to plan how the UK will come out of lock-down we consider what tax changes we could see over the coming months and years to both help re-start the economy and pay for the Covid-19 relief measures.
What changes could we see to the UK tax regime?
In the short-term the focus is likely to be on stimulating the economy - the International Monetary Fund is keen for governments to spend more and cut taxes to drive the recovery and boost business and consumer confidence. But in the long-term the Government will have to deal with the budget deficit and pay back what it has borrowed. Any new measures should:
- help stimulate the economy, or not further damage it
- raise tax revenues, rather than be politically driven
- be simple to introduce and administer, given limited civil service capacity
In 2018/19 UK total tax receipts were c. £620bn. This came primarily from income tax and National Insurance (£327bn), with most of the rest from VAT (£132bn) and corporation tax (£54bn). Smaller amounts came from stamp duty land tax (£12bn), capital gains tax (£9bn) and inheritance tax (£5.3bn).
With this in mind, what initial and longer-term changes could we see?
- Income tax – the top 1% of taxpayers currently pay approximately 28% of all income tax raised (with the top 5% paying around half of all income tax). An increase in income tax rates for high earners is simple to enact and (we would assume) politically acceptable. The extra tax revenue that such a move would raise is highly uncertain, and depends on the extent to which people reduce their taxable incomes in response to the rise in income tax. The Institute for Fiscal Studies estimated that Labour’s 2019 Manifesto pledge to introduce a new 45% income tax rate for annual income of more than £80,000 and a new 50% rate starting at £125,000 could raise £6bn a year.
- Equalising capital gains tax (CGT) and income tax rates – this would increase the CGT collections, although investors may respond by deferring sales. It has previously been considered that a rate of CGT of 28% is optimal for generating tax revenues. Collections could also be significantly increased by removing CGT reliefs (e.g. the personal allowance, the uplift on death, and main residence relief), and taxing all wealth (however generated) equally. Whilst this has been put forward as recently as before the 2019 UK General Election, implementing this would require a major shift in the tax and political landscape.
- VAT – although an increase in VAT would be easy to enact, and a 2% increase would raise approximately £11bn per annum (more than the total raised by capital gains tax), this is unlikely given that the Government will be trying to increase public spending. Following the 2008 financial crisis the then UK Government cut VAT from 17½% to 15% to help stimulate the economy.
- Inheritance tax (IHT) – there was growing speculation, even before the current crisis, that changes to the UK IHT regime were imminent – and in particular that restrictions to IHT reliefs for business and agricultural property were possible (see our previous blog post on whether changes to IHT are imminent). The current IHT system certainly disproportionately impacts those with limited wealth which is mainly tied up in their home, favouring those with relievable business assets and liquid assets that they can afford to give away many years before their death. Abolishing IHT reliefs for business property alone could save the Government an estimated £6bn over the next 5 years. The downside to this change is that it could be relatively complicated to introduce, and the revenues raised would be over a long period of time.
- Corporation tax – an immediate increase in corporation tax may be less likely than an increase in income tax, given that the Government will be seeking to support business growth and encourage inward investment. However, increasing the rate back to 20% (the 2016 rate) is a possibility, and could raise approximately £2.5bn per annum.
Note that the figures above are rough estimates, and assume that the tax base shrinks by 13% (in line with the Office for Budget Responsibility’s prediction for the UK’s annual GDP reduction).
A more radical solution?
Concerns have been raised in some quarters over whether the Government would look to a form of capital levy (i.e. a one-off charge on assets) as a funding solution, such as that favoured by the Labour party following the First World War.
Capital levies can take different forms. A true capital levy is a one-off tax on assets, but other options include enforced Government debt (e.g. liquid assets, however defined, are converted to Government debt to enable the extraction of value from the economy). A more recent example of this was in Cyprus in 2013, where as part of the Euro bailout 60% of savings in excess of €100,000 were confiscated, sometimes in exchange for a limited number of shares in the relevant savings bank
In our view it is unlikely that the UK Government would look to such measures in the wake of the Covid-19 pandemic, and even more unlikely that the Government would consider any kind of confiscation regime. Given the low rates of interest at which the Government can still borrow, and the political backlash that would undoubtedly flow from any such drastic measures, increased borrowing and tax changes are more likely – and sustainable – solutions for the Government to adopt.
One (less objectionable) measure would be to encourage the population to buy Government bonds voluntarily to raise finance. This would no doubt be alongside the significant purchases already taking place by the Bank of England. This doesn’t actually raise taxes, but does push the problem down the line to hopefully better economic climes.
We would expect any tax increases to only be implemented once the initial impact of the Covid-19 pandemic has been absorbed by the economy, and following stimulus measures. Timing will be a delicate balance, but the Government will soon come under pressure to give some indication of how and when it proposes to tackle the costs of the crisis.
Whatever changes are introduced, we would expect any tax changes to have a greater impact on higher earners and wealth owners, as the Government seeks to protect workers and businesses. This will no doubt be alongside additional measures to counter tax avoidance (and evasion), already announced.
What is clear is that, for the foreseeable future, tax rates on wealth will not be lowered, and tax reliefs will not be made more generous. If you are considering taking any action based on current rates and reliefs, it would be worth doing so sooner rather than later. That might include:
- realising gains and paying tax at current capital gains tax rates
- making lifetime gifts under the current inheritance tax seven year gift rules
- making use of business or agricultural property reliefs - for example, by gifting shares outright or into trust
- potentially taking distributions from non-UK trusts, particularly where such distributions would be subject to capital gains tax.
The Government will need to balance any tax changes with its desire to encourage the re-growth of the economy. With this in mind, it seems likely that any tax changes will not be “quick fix” measures. The Government will be taking a longer-term view – seeking to recover additional tax from the economy at the same time as encouraging its recovery.
If you have a question on the above, or would like to learn more, contact BCLP’s Private Client team.
You can view other thought leadership, guidance, and helpful information on our dedicated COVID-19 / Coronavirus resources page.