We’re now, we are promised, on the homeward leg of lockdowns and firebreaks, complete, yet again, with a quick injection of some extra bailout cash to see us through.
The furlough scheme has been extended, the bounce-back loan is a little bouncier, universal credit is providing more universal support than ever, and there are even a few emergency deals hanging over from last time.
These measures and others have been, and continue to be, fundamental for the financial survival of millions in this historic year and those that immediately follow. But they’re costing the nation a fortune.
We know a spending spree on credit – no matter what the motivation – is followed by some tough calls on outgoings, careful examination and management of borrowing costs and, of course, a determined hunt for extra income.
Last week came the ominous news that the Office of Tax Simplification is suggesting changes to capital gains tax (CGT) that could see, for example, the annual tax free amount drop to as little as £1,000, and double-taxing heirs on both CGT and inheritance tax (IHT).
Graham Boar, partner at accountancy group UHY Hacker Young, suspects they are “designed to increase tax revenue and add complexity rather than simplify CGT”. He adds: “They would also create some huge winners and losers.”
So how big is the hole, how do you pay back debt on that scale – and who indeed may win or lose?
For starters, the consequences of spiralling debt are easily misunderstood, warns Edward Cartwright, professor of economics and director of the Institute for Applied Economics and Social Value at De Montfort University, Leicester.
“The fact that debt has risen well above 100 per cent of GDP, from 40 per cent before the financial crisis, does not, of itself, make much difference, provided the government can still borrow money at low interest rates on financial markets.
“At the moment, the government is still able to borrow money at historically low interest rates, and there is no sense this will change in the foreseeable future. Moody’s recently downgraded the UK credit rating, but it was notable they highlighted ‘the weakening in the UK’s institutions and governance’ and Brexit alongside Covid-19,” he adds.
“So, the UK could just end up with a much bigger debt than before, and carry on where it left off before Covid-19.”
That, though, is not the full story. Covid-19 is leading to much higher levels of unemployment and business closures, which means the tax take – even if we “get back to normal” – is going to be dramatically lower than it was pre-pandemic.
Net annual borrowing will be far higher than it was before the pandemic, including at the height of the 2009 financial crisis.
Governments have three ways to deal with debt – increase or maintain borrowing while waiting for the rate of inflation to reduce the real value of the debt, raise taxes and cut spending. There will inevitably be a return to the austerity arguments we’ve become familiar with over the past decade as the public purse tightens and pressure increases on the government to raise taxes to “balance the books”.
“Ultimately that will just slow the recovery,” Cartwright says. “Provided interest rates stay low, it may be optimal for the government to simply ride out the storm and let the economy recover. Yes, debt will spiral even higher but that is the inevitable consequence of Covid-19 and not a reason to push the panic button. Increasing taxes will likely not help.”
In other words, he believes raising taxes will be a political rather than economic calculation, though one set against a backdrop of already rising government debt due to the rising cost of health care and an ageing population.
“As long as the economy grows when the pandemic is over, government revenues will increase – and if government expenditure is closely monitored, a surplus may be created and this can help to retire the new government debt the UK is currently issuing to finance the Covid-19 lockdown,” agrees Professor Fabio Canova from BI Norwegian Business School.
“If the Bank of England continues with aggressive quantitative easing policies, government debt will be exchanged for pound sterling, thus indirectly financing the debt increase with money creation.
“Eventually, this money creation will increase inflation and decrease the value of the debt that needs to be repaid.”
Currently well below the 2 per cent target, a bit more inflation would be welcomed by many.
“All in all, the pandemic is creating economic difficulties in many countries. The difficulties are, however, not different than those caused by wars and, historically, debt increases have been absorbed back within five to 10 years, provided that government expenditures are in check, the economy grows at a robust rate, and the central banks continue with expansionary monetary policy,” Canova adds.
But if that doesn’t happen, or happens too slowly, taxation will have to come into play.
Line of sight
Businesses would be affected first, with the startlingly low tax bills paid by some of biggest businesses operating on our shores offering particularly rewarding hunting grounds. The tax bill for those providing digital services seems set to increase, as does corporation tax in general – currently on the reasonable side compared with some of our European neighbours.
Then there are personal taxes.
“No government, particularly a Conservative one, likes to raise taxes but there may be no choice,” says Sherad Dewedi, managing partner at Yorkshire-based Accountants and Business Advisors.
“The 2019 Conservative manifesto pledged not to raise the big three taxes – income tax, national insurance and VAT. Doing so could be politically fraught.” As would breaking the controversial and expensive state “triple lock”.
“While raising existing taxes may be unpalatable, there is the option of a new tax, of course. There could be a Covid-19 levy on payslips and tax returns, a whole new tax could be created to pay off the virus debt. It would likely last for decades, well beyond the current generation who have lived through tumultuous times.”
CGT and IHT
The obvious targets the government seems to be setting its sight on are the capital taxes including CGT and IHT.
“Both are easy hits, as exemptions can simply be withdrawn or removed. However, doing this leaves the taxpayer fully exposed,” warns Lesley Davis, partner in the private client team at law firm Shakespeare Martineau.
“If the potentially exempt transfer exemption is removed, inheritance tax will become payable on any gifts over just a few hundred pounds in value. More worryingly, if spouse exemption on death is cut then families will have to sell their assets to pay the tax owed. Or, if the nil-rate band of £325,000 is reduced, a tax levy at 40 per cent will apply to the inheritance of a deceased married couple’s children.
“No matter which of these elements of inheritance tax are targeted, many individuals and families will be hugely affected. An increase in capital gains tax could mean a large reduction in profit on the sale or transfer of capital assets.
“For those who have been planning on selling or passing on their estates for some time, this could cause a variety of financial issues. It might seem that a change to these taxes will only create problems for the wealthy, but this isn’t strictly true.
“Anyone who owns their own home and has a level of savings could well find themselves impacted, making them less able to pass on their assets to their children in future.
“To mitigate these impacts, lifetime gifts made now either directly or into a trust could offer some protection. People should also ensure they have properly structured wills that provide the flexibility to move with changes in tax legislation.”
“The most popular way to reduce an income tax liability has long been to invest in a pension, as pension contributions attract tax relief at the investor’s marginal rate,” notes Jason Hollands, managing director for Tilney Investment Management Services.
“In recent years, governments have sought to limit the total cost of pensions tax relief, which is a significant cost to the Treasury and one set to rise over time now that virtually all employees are auto-enrolled into workplace pensions.”
The amount that can be saved annually into pensions has been cut aggressively over the past decade, from an enormous £255,000 a year to today’s £40,000. The highest earners face a tapered annual allowance of as little as £10,000.
“The truth is that most pension tax relief goes to higher rate tax payers, and this regime has been living on borrowed time for several years now. If there was ever a time when there was suitable political cover to remove this relief, it is during this unprecedented crisis,” Hollands says.
“While such a move would not be popular with those impacted, expectations of an eventual overhaul have long been baked in. Those currently benefitting from higher rate pension reliefs should use their allowances while they can.”
Meanwhile, higher taxes and higher inflation are a nasty combination, particular for those savers holding large amounts of cash in savings accounts, he says.
“It is really important to consider the split you have between savings and investments and also the types of assets held and how these might be impacted by rising inflation. An inflation-proofed investment portfolio might include shares, gold, index-linked bonds an infrastructure investments.”
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