The Chancellor has a whole series of dilemmas as he approaches the Budget on Wednesday, 22nd April. Some of these are derived from the credit crunch but others are a consequence of the UK government’s already deteriorating financial deficit and the increasing imperatives for tax reforms.
No Chancellor would wish to have deficits of at least £100bn facing him when he presents his Budget Statement. This is especially the case in what might be his last Budget before the 2009/10 General Election. In the absence of the credit crunch we could have expected higher personal taxes, higher indirect taxes and, perhaps even, higher business taxes. However in the current economic - and political – landscape, all of these might be looked upon as suicidal. Nevertheless, I do expect him to provide some vision of how the government deficit is to be closed over the medium term (say, three to five years) and this must inevitably include both reductions in government spending and targeted increases in taxation - as financial markets are unlikely to consider the former to be sufficient on its own.
In the area of personal taxation, it appears that the political consensus of a basic rate of 20 per cent and a higher rate of 40 per cent has now been broken by his announcement in last year’s Pre-Budget Report of a 45 per cent income tax rate (for incomes over £150,000) in 2011/12. We expect further increases on the higher paid, to be implemented after the General Election, such as the restriction of some tax allowances to the basic rate of relief.
So far as VAT is concerned, the temporary reduction to 15 per cent (from 17.5 per cent) has not been met with much approval, even from the retailers who were expected to benefit most. It should be borne in mind that the UK has a relatively low rate of VAT in comparison to our major European competitors. The Chancellor could well suggest that the rate may have to be increased to above 17.5 per cent, perhaps to 19 per cent from 2010/11. Arguably, the "stick" of a higher rate coming in may be more effective in bringing forward consumer spending than the "carrot" of the temporary reduced rate.
So far as business taxation is concerned, the Chancellor needs to continue reducing the main rate of corporation tax (currently 28 per cent) to 25 per cent in the short term and perhaps to 20 per cent in the longer term. This may mean less generous reliefs in some areas such as targeted reliefs and capital allowances. Hopefully, HMRC will have identified a sensible approach to the exemption of foreign profits from UK corporation tax in the interest relief rules. These must not unduly restrict arms' length financing arrangements, or involve an excessive compliance burden, but will need to provide the Treasury with sufficient protection of the UK tax base. Business taxation remains a highly competitive area between both developed and less developed economies and the Chancellor cannot "wish away" the need to compete. He must provide both favourable rates and a business friendly tax environment for increasingly mobile global businesses.
All in all, the Chancellor faces his most difficult Budget and there is no clear way to secure a favourable response from global financial markets, the UK business sector or the personal tax payer. It is quite possible that all of these three groups will be dissatisfied when he sits down around 2pm on Wednesday, 22nd April!"