How will we pay for the pandemic? A study of tax changes in the brave new world

All bets are off. As Rishi Sunak, our Chancellor, announced in one of his speeches offering far reaching financial support to all in response to the COVID-19 pandemic:

‘If we all want to benefit equally from state support, we must all pay in equally in future’.

Whether you believe or not the government has managed to support everyone equally through this crisis, one thing is inevitable in this now uncertain world - tax rises are coming our way.

The Budget in March, dubbed by us as the Coronavirus Induced Budget, promised unlimited cash for all to get through the months of uncertainty caused by COVID-19. Sunak was hailed a hero by many, employers and employees like, but his glory days are unlikely to last despite his excellent speech giving. With each day in lockdown, the budget deficit mounts on a surge of massive public spending. It is estimate the UK will have a budget deficit in the range of £337 billion by the end of the pandemic. Eye watering.

What could be Sunak’s next move?

Sunak faces tough choices and there is no easy solution to decreasing the huge budget deficit the UK faces. Sunak could increase government borrowing which would cover most of the shortfall, but the prime minister has already ruled out deep cuts to public spending which have already experienced over the last ten years, since the 2018 financial crash. The alternative is tax rises, which would demonstrate a commitment to reducing the deficit.

What tax rises are we likely to experience?

A treasury leaked document last week showed a shopping list of potential tax rises that may come into force after the pandemic. Tax rises are inevitable but the government also needs to kick start the economy as soon as they are able and with it, look to protect jobs so as not to increase the tax load on to businesses.

The expectation is that the burden of tax rises is likely to fall on wealthy individuals, perhaps through a wealth tax, and also the self-employed, with IR35 regulation rearing its head again from next April. There could also be some tax reliefs that are removed, perhaps to pensions and property.

Here we look at the various taxes in turn that could experience an increase and impact all of our tax bills.

Income Tax

Income tax accounts for nearly a quarter of total tax receipts to the Treasury, so would be the easiest and quickest way to raise tax revenue. But raising income tax would be hugely unpopular amongst the electorate and goes against the Conservative manifesto, which states that they would ‘not raise rates of income tax, national insurance or VAT’ - the three biggest contributors to tax revenue.

Many believe that, due to these unprecedented times, taxpayers would be forgiving if the Tories reneged on this promise. HMRC research shows that small income tax rises for large numbers of people, versus targeting higher earners only, raises a heap more tax revenue. For example, a single percentage point increase in the basic rate of income tax from 20 to 21 percent would raise £4.7 billion. Increasing the higher rate from 40 to 41 percent would, in contrast, raise £1 billion in tax revenue, reflecting the small number of people in the higher rate tax band currently. Furthermore, an increase to the additional rate band from 45 to 46 percent would raise only £105 million. In reality, we could well see an increase in tax rates to all taxpayers, versus just one group of taxpayers.

Another option that would bend rather than break from the Tory manifesto would be to abolish the personal allowance, currently set at £12,5oo in the 2020/2021 tax year. This option is unlikely or if it is abolished it will likely be replaced with a new lower rate tax band of say 15%, bearing in mind the lowest earners would need the most protection coming out of the pandemic.

National Insurance (NIC)

National Insurance contributions is the tax which most likeliest will be increased and which will prove to be the least controversial versus raising income tax. Currently, NIC charges are complex and differ for different bands of earnings and categories of employment, and is screaming out for reform.

The Chancellor may consider scrapping the NIC’s upper earnings limit. Currently, employees pay 12% on earnings between £9,501 and £50,000, and income above £50,000 is taxed at 2%. So if the 2% was abolished and a flat rate of 12% was introduced across all levels of earning, someone earning £100,000 would see a £5,000 reduction in their net annual pay, even if income tax rates were left unchanged. Quite a hefty difference and one that most definitely be felt.

Another option would be to align NIC with the personal allowance of 12,500 rather than the start at the existing £9,5000 threshold. This would be a boost to lower income earners but the Treasury would earn that back and more for those earning above £50,000.

There may also be a NIC payment expectation for those over the state pension age who are still earning a salary. This could be an easy argument to win, and would be seen as a contribution to the state pension by pensioners which they would enjoy when they retire.

Self employment

We heard from the Chancellor, when he announced the Coronavirus Self Employment Income Support Scheme (SEISS) that the self employed should be aware of increased tax bills from April 2021 as a quid pro quo for offering the SEISS.

Currently, self employed people earning above £9,501 a year pay Class 4 NIC at 9%. This is in contrast to employed workers who pay 12%, something which Sunak has said is ‘much harder to justify’.

There is an inevitability to the NIC increase to 12% for the self employed, and we believe the government may go even further. The government may look to align the NIC for self employed by aligning it with what employers currently pay for staff on their payroll, with a combined rate of employee and employer NICs. This is very radical but is indicative of how much the tax system for the self employed is requiring a thorough review and overhaul.

With IR35 regulations looming in April, it is feared that the self employed will be singled out to receive the most tax hikes, the very entrepreneurs and risk takers that Sunak claims he wants to help after the pandemic. Watch this space.

Pensions

Even before the pandemic, the pension tax breaks received by higher earners was under threat. It has been estimated that £10bn could be clawed back by the government if pension contributions were restricted to basic rate of 20%. This could be the one chance the Chancellor has in the upcoming Autumn Budget to cull the higher earners pension relief, a time when he would most likely get away with it.

The Chartered Institute of Taxation (CIOT), our institute, has suggested that the Chancellor could structure pensions like ISAs, which are funded from taxed income but income is extracted tax free. Interesting concept and a format easily explained to taxpayers.

The more pressing decision that the Treasury will need to decide on is the “triple lock”, which guarantees an increase to the state pension every year by the higher of inflation, average earnings or a minimum of 2.5%. The likelihood of increased inflation and wage growth in the post pandemic era is small, experts believe then the 2.5% figure will need to be revisited and be revised down.

Property taxes

We all enjoy Private Residence Relief (PRR) in the UK, exempting us from capital gains tax on our main home when we sell. This tax relief is estimated to have cost £26.7bn in 2018/19. Changing this tax relief would, however, be hugely controversial but it is under threat, bearing mind the government has already brought in property tax changes from April this year relating to capital gains tax for individuals selling a property: the CGT relief you receive on selling a second home or a buy-to-let property was halved from 18 months to 9 months. You can read more here on how the changes could affect you.

During Phillip Hammond’s reigns, which feels like a lifetime ago now along the Brexit saga, it was rumoured that the PRR would be capped at £225,ooo and any gains above this amount on the sale of your main home would be subject to capital gains tax at 28%. But would the Chancellor be prepared to see this through at the mercy of negatively affecting sales and house prices, remains to be seen. If a property crash occurs there will be a swathe of properties in negative equity, especially those concentrated in our larger cities, and in the context of the Brexit effect looming.

It may be that the government will go completely the other way and look to make property tax cuts to get the housing market moving, for example maybe a cut to stamp duty land tax for house purchases below a certain level. They could even look to abolish the 3% stamp duty land tax surcharge for second property purchases.

And what about council tax rates? An overhaul of the council tax system with local authorities would be a mammoth task and again not favour traditional Tory voters.

There is no doubt that the majority of these tax changes if enacted would cause much uproar in normal times. But these aren’t normal times, and the Tory government will likely have to move drastically away from the promises of their manifesto to fill up the coffers again

Our Assessment

Reducing, rather than increasing, taxes generally increases tax revenues over the mid-term as it stimulates growth in the economy.

In a post pandemic world, increasing taxes in an already damaged economy will in our opinion cause more damage than good. The Government could act to reduce business taxation for example, ensuring revenue is pumped back into the economy. There could also be an introduction of corporation tax bands to benefit smaller and mid sized businesses to stimulate growth and foster entrepreneurship.

This is a once in a lifetime opportunity for Sunak and the government to overhaul the tax system. Let’s hope they do the right thing for all.