The Covid-19 pandemic has been expensive both in terms of human cost and economically for individuals, businesses and governments.
Furlough payments are costing governments around the world mind-boggling sums. While those payments have been welcomed from those struggling to stay afloat in these tricky times, the payouts have created huge deficits, which continue to increase, and which will eventually have to be recouped from somewhere. And there are no prizes for guessing how governments will seek to do that: by raising taxes.
That much is certain. What is up for debate is how they will choose to do it and who is going to come off worst. This article concerns the UK but wherever you are from, your government is likely to be wrestling with the same dilemmas.
In the UK, the Financial Times has estimated a budget deficit in excess of £337bn caused by increased public spending as a result of Covid-19 combined with a loss in tax revenue due to the looming recession. Which leaves the promise of tax cuts made in the conservative manifesto looking impossible to keep. It looks like there are going to be some unpopular decisions taken by Boris, Rishi Sunak et al and some of these could impact you if you are a British national, own assets in the UK or plan to move there.
Here are some of the options open to the UK government to counteract the Covid-induced deficit and some possible economic and political implications of each:
Cut government spending
Government spending in many areas already shaved to the bone as a result of austerity. Cutting this further is an unlikely possible solution.
Raise income tax rates
This would be perhaps the quickest, easiest and most impactful tax to target given that 25% of total tax receipts in the UK come from income tax. The problem is that increasing income tax is contrary to the government’s late 2019 manifesto pledge to ‘not raise rates of income tax, national insurance or VAT.’ Doubtless the government will argue that exceptional times call for exceptional measures and hope that the public will be understanding given the circumstances. One option to soften the blow would be to put a time limit on the increased tax rate until the pandemic is paid for but governments aren’t known for keeping their word and the public may view it as yet another hollow promise.
The struggling middle classes will clearly favour income tax increases which only target high earners but research from HMRC suggests that a 1% increase on the top additional rate tax band of 45% would raise just £105mn compared to the £4.7bn estimated haul from a 1% increase in the basic tax rate. The increase on the highest earners would need to be significantly bigger to make any impact at all. Of course it doesn’t have to be an either or decision. Different percentage rises could be applied to different tax bands.
Abolish the personal tax-free allowance
Another option for the government is the abolition of the personal tax-free allowance of £12,500. Technically this would enable the government to keep its pledge to not raise rates of income tax. This would hit poorer households hardest although they could be partially protected with the introduction of a lower tax rate specifically for low income earners. Nevertheless, this is the group who can least afford to repay the deficit caused by Covid and there will be pressure to protect them.
An alternative for the chancellor would be to drop the rate at which the personal allowance starts to be restricted. At the moment, when you earn over £100,000 per year your tax-free allowance starts to fall, disappearing altogether when earnings reach £125,000. The counter-argument to this option is that it hits middle income earners who are already penalised when their earnings reach £50,000 as child benefits starts to reduce.
Increase National Insurance Contributions (NICs)
The government might view the Covid-induced crisis as the ideal opportunity to reform the overly complicated NI system with its numerous different rates depending on salary and job, something they have long desired to do. They could approach this in a number of different ways.
At present there is an upper earnings limit on NICs which are payable at 2% on earnings of over £50,000 compared to 12% on anything between £9,501 and £50,000. This limit could be removed in a move that would hit the highest earners and be more palatable to the majority of UK taxpayers.
Similarly, those over state pension age who are still working don’t currently pay NICs and this could be changed in what is thought of as one of the less controversial options open to the Chancellor.
The self-employed will rail against any rise to the 9% NICs they currently pay (if earning over £9,501), against the 12% paid by businesses for their employees, but Rishi Sunak has already stated that this difference is hard to justify. Many experts think an increase is a no brainer for the government and believe they could go even further to match the self-employed rate to the combined rate of employee and employer NICs in the face of pressure from lobbyists including the Institute for Fiscal Studies.
End state pension ‘triple lock’
The triple lock on annual increases to the state pension guarantees that pensions rise by at least 2.5% or to match inflation or earnings growth, whichever is higher. Commentators are saying that this percentage will have to be reduced and that doing so could swell state coffers by £8bn according to documents leaked from the Treasury. It won’t be a popular decision though.
Cutting pensions tax relief
Pensions tax relief for higher earners is a prime candidate for reform having been singled out by the National Audit Office (NAO) as the UK’s most expensive tax break, costing the government £38bn in 2018-19. While cutting this might have seemed radical a year ago, partly because it will hit the Tories’ core supporters hardest, it could now be a viable option and one of the more palatable solutions for voters.
Increase capital gains tax (CGT)
The CGT personal allowance is £12,300, which the government could potentially abolish to raise revenue, either for everyone or for higher earners. Above that CGT is currently charged at 18% for basic tax payers on property and 10% on other assets. Those subject to higher tax bands pay 28% and 20% respectively. Alternatively the government could choose to align CGT with income tax rates of 20%, 40% or 45% or introduce a flat rate higher than current rates.
Increase inheritance tax (IHT)
IHT is another tax which there have been numerous calls to reform although it’s not one of the government’s biggest earners with revenues of around £5.4bn per year. Some say the government may look at scrapping it and returning to a capital transfer tax, levied on the transfer of assets whether the owner is alive or dead. This tax existed in the UK in the 1970s and 1980s. Another option would be to align IHT to capital gains tax.
Business tax
Businesses have suffered as a result of the pandemic and lockdown and increasing business tax is unlikely to aid economic recovery and could mean further job losses. It’s unlikely the government will choose this route to boosting its coffers.
Property tax
Private Residence Relief (PRR) is an exemption from paying capital gains tax when a homeowner sells their main home. The government has already reduced the period during which homeowners are exempted from CGT after moving out of their homes from 18 to nine months and some tax specialists believe it could be abolished altogether.
Abolishing PRR is potentially a big cash cow, valued at £26.7bn for the 2018-19 tax year but it would be a seriously unpopular move. It would also dissuade homeowners from selling which would be counter-productive for a government keen to get the housing market moving again. Indeed some experts have mooted the possibility of a reduction in stamp duty for property sales under £750,000 with a view to jumpstarting the market. Capping private residence relief is a less drastic option and could be a halfway house solution.
Revising council tax bands
The eight different council tax bands are based on property values from 1991 which are obviously massively outdated. Revaluing them would be hugely controversial but could bring much-needed funds to struggling local authorities. It’s hardly a vote winner though.
The unique economic landscape post-covid might prove to be the chance the government have been waiting for to reform certain elements of the UK tax system which previous governments have not dared to tackle. It will be interesting to see what they decide to do.
Tax is a very complicated subject of course. Numerous factors come into play to determine how and where expatriates pay tax and, as the above proves, the goal posts are constantly changing. That’s one reason why you should regularly review your tax planning to ensure that you aren’t overpaying when simple steps could be taken to reduce your tax burden.
If you think you could use some help assessing your situation, I’d be happy to take a look at your financial planning and suggest how it might be improved to protect you and your family. Please contact me at cturner@infinitysolutions.com.
A leading provider of expat financial services and wealth management services across Asia.
