Is there headroom for tax cuts in next week’s Budget, and if so, what will they be?
The ‘headroom’ is, of course, a wholly fictitious number, created by arbitrary targets and policed by the OBR – whose recent forecasting was described by Richard Hughes, the man in charge, as ‘beyond a work of fiction’ in January as the Government failed to deliver sufficient information on its spending plans. The bond markets on the other hand, are the real judge, jury and executioner, as Liz Truss found out to her cost 18 months ago.
Recent research by the Financial Times suggests that pre-election tax cuts are less usual than we would think; however, it is probable that there will be some pre-election tax giveaways to win over voters, irrespective of the headroom available to the Chancellor.
Given the proximity to the General Election, we expect measures focused on individuals rather than businesses, with an emphasis on headline grabbing policies such as further reductions to National Insurance (NI), abolishing Inheritance Tax or even changing the rules for non-doms. Cutting NI is appealing for the Government as it could impact the whole UK, which is not within the powers of a devolved government to reverse. It also creates a political dividing line which could be electorally useful in a few months’ time.
Our expectations have already been managed about the size of any tax reductions given that the UK’s economic growth in the short term has been poor. We have been flirting with recession and the Chancellor has been quoted as saying there is “less scope” for tax cuts than hoped. Indeed, both the International Monetary Fund (IMF) and Institute for Fiscal Studies (IFS) have suggested the Government should not cut taxes without spelling out how they are affordable.
There has been some speculation the Chancellor, Jeremy Hunt, may look to find ‘other sources of income’ to pay for the tax cuts. That is presumably why the non-dom regime is now under scrutiny because it allows the Chancellor to take tax receipts from the future – gaming the headroom calculation – to spend the proceeds now.
The Chancellor has very limited options and may look to reduce public spending to create the headroom to fund tax cuts. Cutting spending is not generating more income, however it is dressed up. This short-term approach though could see a reduction of services to deliver tax cuts today which an incoming government may then have to reverse tomorrow.
The impact of proposed tax changes to the UK economy:
- National Insurance: A 1% cut would cost the economy £4.5 billion per year, and this follows a cut made to over 25 million workers in the 2023 Autumn Statement.
- Inheritance Tax: Applying to less than 5% of households; however, abolishing it costs an estimated £7bn to Government revenues.
- Reversing fiscal drag: Allowing tax thresholds to increase (possibly in line with inflation) would benefit millions of struggling UK households.
- Cutting income tax by 1p: This would cost an estimated £7bn, according to the Resolution Foundation.
- Abolishing the “non-dom” rules for foreign nationals living in the UK: This may raise around £2bn and benefit the Chancellor by offering him more scope for tax cuts. However, any changes could limit Labour’s ability to fund their election pledges.
- Freezing fuel duty: Scrapping the planned 5p increase would cost around £2bn.
- A new vaping levy: Introducing a levy on vaping products, together with an increase in in tobacco duty, raises around £0.5bn annually.
Crowe’s recommendations to Government
Ahead of last year’s Autumn Statement, Crowe UK provided an open submission to HM Treasury highlighting potential tax reforms and many of these remain areas we recommend the government consider for Spring Budget:
- Reducing ‘red tape’: The ‘fiscal drag’ caused by people and businesses paying a higher tax rate following last year’s Autumn Statement acts as a disincentive for growth. The new tax regime becomes more onerous as more organisations are subject to rules designed for larger entities, when an entity’s activities have not significantly changed.
- Remove ‘cliff edge’ VAT thresholds: Cliff edge of the VAT threshold for some small businesses is preventing them from expanding as they actively restrict turnover to remain beneath the compulsory VAT registration threshold of £85,000. A survey by the Tax Policy Associates calculated that 26,000 businesses were deliberately restricting growth for this reason.
- VAT sales relief: Aimed at hospitality and leisure businesses, sectors which have been particularly exposed by the challenges of the economic climate, VAT relief could help revitalise UK towns and highstreets by stimulating consumer spending.
- Improve the interaction of the tax and benefits systems: A focus on the absurd levels of marginal tax created by the interaction of the tax and benefits systems could incentivise people to work, to take on more work, or seek promotion.
All Budgets are spectacular events, often as focused on politics as they are on economics and sensible tax policy. However the announcements are dressed up in the current difficult environment, what benefits the UK in the long run is encouraging economic growth in order to reduce the tax burden and protect public services.