As the third Finance Bill of 2011 was given Royal Assent on Tuesday 19 July, thoughts at the Treasury will now be turning towards the 2012 Budget.
The CEBR’s most recent United Kingdom Prospects Report forecasts that annual real GDP growth for the years 2011-2015 will average just 1.8%, somewhat lower than the 2.6% annual average forecast by the Office for Budget Responsibility (OBR). As a result, the budget deficit in the fiscal year 2015/16 would be £25bn higher than the OBR is currently forecasting, with public sector net borrowing (PSNB) standing at £54bn rather than £29bn.
Ultimately, this would mean that tax receipts may grow at a much slower rate than the OBR is anticipating. The Treasury would undoubtedly then put further pressure on HMRC to increase tax receipts through higher scrutiny and further stepping up the already sharp focus on avoidance. Although the CEBR expect that the changing mix of tax receipts will offset some of the effects of the slower growth, it still forecasts that tax receipts will grow at an average annual rate of 5.4% between 2011/12 and 2015/16, compared with the OBR expected growth of 6.0%.
Whilst it’s always dangerous to place too much significance on any forecast, I have given some thought as to the possible consequences of the OBR’s views being too optimistic and the CEBR's views being more realistic. The Chancellor may be minded to meet the resulting fiscal challenge by continuing to try to make the UK’s tax regime and rates more attractive to a wider range of international businesses. However, will this be enough if the outlook is significantly worse than the Government currently predicts?
Sudden shocks to the tax system (for example those to the banking and oil sectors in the 2011 Budget) have already undermined the Government’s published roadmap that tax policymaking should be widely consulted on, for the long term, and aligned with business practice.
Mr Osborne would also loath to reconsider the recently announced tax changes intended to stimulate entrepreneurial activity and the attractiveness of the UK to international businesses. He also still needs to resolve the challenge that the 50% income tax rate presents to making the UK an attractive location for the entrepreneurs and wealthy individuals who own and run these businesses.
So what room for manoeuvre does he have with the major taxes?
This expression has become so politicised and inconsistently defined that it has started to lose all meaning. However, huge progress has been achieved in relation to combating tax avoidance, pre-packaged and artificial schemes, enhancing HMRC’s investigative powers and offering various communities the opportunity to “come clean”. This weaponry will no doubt continue to be enhanced and supplemented as new avoidance schemes are designed.
Even one of the previously more certain ways to minimise UK tax liabilities, to leave the UK altogether, is becoming more difficult, following a string of legal cases and the proposed statutory residence test.
Mr Osborne is committed to increase the personal allowance towards £10,000 and needs to introduce this whilst having regard to the starting level of the 40% rate. As a revenue (if not popularity) raising measure, he may be tempted to increase the basic rate of income tax towards the 25% level that it stood at when the 40% higher rate was first introduced in 1988, whilst extending the basic rate band. This would significantly raise revenue as it is paid by a broad tax base, with low marginal cost of collection and difficult to avoid.
The biggest challenge on income tax, however, is how soon the 50% top rate of tax can be reduced or abolished. The growing negative effect of 52% (including NIC) taxes on income is surely the greatest remaining challenge to making the UK an attractive place for the wealthy to pay their tax.
The Chancellor has very little room to increase the “tax on jobs”. Whilst he is committed to considering the alignment of its collection with income tax, and may possibly seek to merge the two regimes in due course, this is a tax that would be difficult to increase.
Now that Entrepreneurs’ Relief carries a tax saving £1.8m (a huge increase on the original level of £80,000), Mr Osborne may consider that he has room to increase the mainstream rate of 28%. There are, however, many entrepreneurial activities that do not fall within the qualifying definition for ER, and other activities that he may want to tax at a lower level (for example management shareholdings under 5% and share options).
Mr Osborne may choose to realign CGT rates with income tax rates (possibly in conjunction with the abolition of the 50% income tax rate) or limit principal private residence relief to either a percentage gain per property or a lifetime allowance.
Making the UK a competitive location for companies is one of Mr Osborne’s primary tax objectives. The changes already announced, moving to a more territorially based tax system, reductions in the headline rate and enhanced incentives for R&D, all acknowledge that a lower tax regime is likely to increase tax revenues. We could therefore expect the mainstream CT rate to be cut to 20% or lower.
The three recent changes in VAT rate have proved that this can be a straightforward tax to change. When the inflation rate has digested the consequences of the last VAT rise to 20%, and if Mr Osborne needs to generate further tax revenues, how surprised would we really be to see the VAT rate increase by another 1% or 2%?
Specific taxes on banks, oil companies and utilities have been expedient and profitable in the recent past, but cannot easily be reconciled with a longer term roadmap for tax policymaking. However, such taxes have a much less direct effect on voters than those analysed above and should not be dismissed.
In conclusion, the Chancellor has little room for manoeuvre on most of the major taxes, and it would seem that any further top ups required to tax revenues will need to come from the tried and trusted method of VAT rises, industry specific taxes, or a complex realignment of income tax. The latter seems least likely. Corporates (with the possible exception of those in sectors susceptible to industry specific taxes or unable to recover VAT or pass on increases to customers) should draw some comfort that corporation tax and Employers NIC seem the least likely taxes to be increased.