By David Manning - Manager, Blockchain & Crypto Team While the title might seem dramatic, it is certainly the sentiment you will find across the array…
The impact of the coronavirus crisis on UK public finances is starting to become clear in official figures. In April, the government borrowed £62.1 billion – more than in any month on record – and the budget deficit could widen further as the Coronavirus Job Retention Scheme and other measures continue in the coming months.
Bloomberg has estimated the UK government will borrow an extra £220 billion this year, on top of the £55 billion already forecast before coronavirus hit. That figure is made up of the £140 billion cost of the government’s policy responses, plus an £80 billion shortfall in tax revenue due to the economic slowdown.
How will this massive hole in the public finances be filled? John Endacott and Daniel Sladen discuss the outlook for taxes in the UK in the aftermath of coronavirus.
Is it inevitable that taxes will have to rise as a result of the huge cost of coronavirus? Or can we just keep servicing the increased national debt?
DS: I’m pretty sceptical about across-the-board increases in taxes despite the recent briefing coming out of the Treasury – it doesn’t feel like the kind of hard choice this government would want to make. I believe we’re more likely to see a move towards tax cuts or payment deferral in the short term, while in the medium term tax rises will be largely impossible because a lot of businesses will be in no shape to pay increased taxes.
JE: So where is the money going to come from then?
DS: If the UK political debate continues to be a contest between national populism and traditional centre-left economics, further austerity is off the table. The Prime Minister has explicitly said there won’t be a return to austerity. So the answer has to be debt.
Rather than “repaying the debt” when things return to “normal”, we’re looking at a period of high public debt and deficit spending for the foreseeable future. It’s still completely unclear how the government can move to a balanced budget in the post-coronavirus economy.
JE: I get the temptation for the government to increase debt instead of increasing taxes, but is that possible, or wise?
In my view, in the short term at least, there seems no doubt that the government will fund the emergency spending packages by taking on additional borrowing. Its total debt could increase very substantially and yet debt interest as a proportion of total spending would still be relatively modest, as long as it can be financed at the current very low level.
However, there is a limit to how much debt the country can afford to take on. It is not clear when that point will be reached, but I think some tax rises are likely to be necessary to fund additional spending on health, debt interest and social security benefits, as well as to demonstrate financial prudence to the markets.
At the moment, the UK can borrow very cheaply but that could change if investors start to question the government’s ability to pay its debts. Do we have a credible government and an economy that investors across the world are prepared to back?
DS: What you’re saying is no one wants to end up like Greece 10 years ago. The difference this time is that most major economies will be in a similar position, so the threat of being “the next Greece” won’t have the same resonance now.
The impact of the pandemic can be compared to a world war, and high long-term debt levels eventually being dealt with via inflation have been accepted in such severe situations in the past. So I think increased national debt looks like a rational strategy in the medium term.
JE: Even so, I think all roads eventually lead to additional taxes – it’s just a case of which ones, how much, and when.
So which taxes could increase?
JE: Tax rises will be driven by what is politically acceptable. Larger corporations look a relatively easy target. With the recent U-turn on a cut in corporation tax from 19% to 17%, it already looks like the low point for corporate tax rates has been passed and an upswing could have started.
The reduction in UK corporation tax over recent years has been funded by reducing tax relief on capital expenditure and restricting tax relief for interest and losses. Corporate tax could be raised by stealth by further restricting loss and interest relief, although if the aim is to re-balance the economy and increase manufacturing in the UK, the government might want to incentivise investment by making plant and machinery allowances – and the structures and buildings allowances – more generous.
DS: I agree that this kind of tax raising through complexity is the easiest target; it doesn’t generate a public perception that tax rises are happening. But there are limits to how much can be raised by this route, so the question is how much further the government might go.
The reaction to the 2019 Conservative manifesto and this year’s Budget showed the UK electorate is keen on a combination of low taxes and increasing public spending and that there are no prizes for telling the voters things they don’t want to hear. So I’d expect no headline rises in income tax, National Insurance or VAT, and increased spending branded as “investment in the recovery”.
JE: Whether or not National Insurance increases across the board, it is likely to increase for the self-employed. When he announced the Self Employed Income Support Scheme, Rishi Sunak made clear that he would look to return to this issue and increase Class 4 National Insurance in future. Appeals by directors that their dividends were in fact earnings are only likely to make it easier for the government to also consider charging National Insurance on dividends to owner managers.
DS: Yes, it will be difficult to argue for a beneficial tax treatment in future now it’s been seen that government underwrites the risk of the self-employed as well as the employed. As a result, Rishi Sunak is likely to have an easier ride than Philip Hammond if he dusts off measures to level the playing field between the employed, the self-employed and those working through limited companies.
What else might the Chancellor do?
DS: I think most tax changes are likely to be either “costless” increases or populist measures intended to signal that the government is on the side of “ordinary voters”.
On the “costless” side, I agree that we can expect to see heavier restrictions on the use of brought forward losses, particularly those made during the pandemic. A case can be made for profitable businesses paying tax as soon as they begin to recover, with loss utilisation tightly capped or streamed. A similar logic might be applied to reduce capital allowance rates while increasing annual investment allowances to encourage new investment.
JE: What about more populist measures?
DS: There will be some groups it is important for the government to be seen to tax. I still think wealth taxes are likely to remain in the “too difficult” category, but offshore holding structures will be in the firing line when UK taxpayer support has helped keep their businesses going during the pandemic. I’d expect to see further anti-avoidance and transparency measures announced – and perhaps even implemented.
JE: Speaking of wealth taxes, I think the government could reduce inheritance tax and capital gains tax reliefs on businesses and property – both as a means to directly raise tax revenue and counter accusations of unfairness.
Business and agricultural property reliefs, capital gains tax re-basing on death, and having an unlimited main residence relief are all possible areas that could be restricted, as well as pension reliefs. In my view, even a one-off wealth tax is a possibility in extremis for the government, though it may not raise much revenue.
Are there any other taxes on businesses or property that might change?
DS: Because it’s always easier to tax those who have money, the online businesses already emerging as winners in the new world will be expected to pay more. It’s hard to guess exactly how far and how fast we move toward turnover and digital services taxes, but the popular pressure to be seen to tax the businesses that have had a good crisis will be difficult for any government to resist. Whether they can be made to work is another question entirely.
JE: I agree that an increase in the digital services tax on US tech giants looks possible. This might be especially relevant to the fall in revenue from business rates from retail and high street businesses. The government can’t afford to lose that revenue and needs to find a way to replace it, so a major reform of non-domestic rates remains likely.
DS: How about other property-related taxes?
JE: Well, Stamp Duty Land Tax receipts may well remain subdued and a reduction in tax rates may be necessary to help stimulate both the housing market and tax revenue. A reduction in SDLT rates could drive the government to grasp the nettle and reform council tax to make it fairer by increasing the tax payable on larger houses.
DS: What about Brexit?
JE: Well there could be an upside to it, in that it may give the government flexibility and enable more excise taxes and customs duties to be imposed. The outlook for fuel duty is unclear – we have seen a big drop in car use during the lockdown but cars now look like a safer option than public transport for the foreseeable future. How fuel duty and air passenger duty fit in with the government’s transport infrastructure plans and green agenda is very hard to say right now.
DS: It is a totally different world, and many of the favoured stealth taxes have literally run out of road: it will be hard to tax travel when not much of it is happening; hard to tax consumption when we want more of it; and hard to tax physical premises when far more commerce is happening at home and online.
When could tax rises happen?
JE: The government has a dilemma here. It’s unlikely to want to push up taxes too quickly for fear of stifling the economic recovery. It would be self-defeating to keep companies on life support now only to clobber them with increased taxes as they start to get back on their feet.
But from a political point of view, the danger of kicking the can down the road is that taxes would need to rise shortly before the next General Election in 2024, which probably won’t be a vote winner.
Notwithstanding those concerns, the numbers are so big that the additional tax required to pay the debt interest, to increase funding on the NHS and to settle the social care issue alone will require a huge amount of additional tax revenue. And that’s before you factor in potentially higher social security costs in the longer term.
DS: 2024 is definitely the key milestone, but politically the only thing worse than going into an election off the back of tax rises would be an ongoing recession.
We hope that at some stage, the economy will move from this stabilisation phase to recovery. This looks like a slow, painful process, with consumers reluctant to spend, fewer enterprises remaining in business and continued restrictions on many sectors limiting economic activity.
The challenge for government in this phase will be to restore growth and stave off recession rather than to bring the public finances back into balance. So in my view wholesale tax rises will have to wait until there is a sustainable recovery.
What should businesses and individuals do to prepare for future tax increases?
JE: The future is uncertain but the outlook for taxes is up. I would urge businesses and individuals to plan ahead and to consider taking action now to best structure and organise their affairs for the future.
DS: Whether or not there are increases in tax rates, complexity will be on the up, so businesses need to stay alert to any changes and make sure that they can take advantage of incentives that are on offer to help them recover. With changes to both the tax system and the overall economy, the rationale for current business structures might no longer apply, so be prepared to be more flexible and to review new opportunities.
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