For as long as I can remember, I have written a kind of alternative budget blog – not full of facts and figures, like all the other accountants, but a bit outspoken and opinionated. Just once a year.
This year, however, I have had an unforeseen problem – a serious one which stopped me in my tracks. My two sons have become way more knowledgeable than me. Whilst that has made me really proud, I found when I sat down to write this, that it made me very hesitant. I didn’t want to look a fool to them and I was being a bit cautious.
As it happens, there’s virtually nothing to say about the tax side of things, so what I decided was that I’d ask my youngest son to give my long suffering readers some valuable insights on the economic aspects of the budget. By way of an introduction, Luc works for the Treasury in a department reporting to Rishi Sunak that advises on the long term effect of fiscal policy. Luc actually wrote a whole section of the Budget Review (Appendix A of the document below, if you’re interested).
Let me get my bit out of the way first – tax things that might affect you.
- The main news is no real changes to anything, of any significance. There’s only tiny things, which I don’t think are worth mentioning – you will have read these.
- The Minimum wage goes up to £9.50 per hour
- Some fairly insignificant business rates relief for retail, hospitality and leisure sectors which just doesn’t cut it, I’m afraid – too small to help sectors suffering real problems.
- Increased R&D investment along with a promise to modernise the system – my interpretation of that is that small businesses will get less and large businesses more – I think the Chancellor thinks small businesses are serial tax avoiders and R&D claims are part of that.
- The main points to mention are old news – corporation tax rates go up to 25% in April 2023 which is a huge change. Also NIC for employees and employers, together with dividend tax, will increase by 1.25% from April 2022 to fund social care. More later.
Now on to the interesting bit – some economic insights from inside the system…
So Luc, give me an oversight of the Government’s thinking when it comes to the Budget
“Right, Dad, this Budget is basically a spending review and there’s 3 main factors that would determine your spending policy:
- Providing goods to the public to meet public service backlogs (eg healthcare & education)
- There’s a political angle, (eg levelling up, or net zero, where Boris wants to spend loads)
- The macroeconomic angle where the government wants to support the economic recovery. It has traditionally done this by manipulating interest rates (known as monetary policy), but interest rates have been so low that there is no room to cut them any further. The other option is to spend more to inject money into the economy, but the government is constrained by its level of debt and the possibility of interest rates and inflation rising, which would make this debt much more expensive
Essentially, the Gov’t have realised that there is a need to spend more money on public services. Broadly, this realisation has come from two things: (i) the population is getting older and so requires a lot more spending on health, social care and pensions, and (ii) the austerity that came after the financial crisis reduced funding for public services, rather than increasing it in the face of these ageing pressures. The former is a big pressure for the public finances. It is not a new problem though, but has been funded through long-term reductions in spending on defence and overseas aid over time that have avoided the need to raise taxes. There isn’t much room to cut these any further and so something has to give – either you reduce state provision of goods and services (privatisation), or you find new ways of funding these things (the tax increases announced up to this Budget).
Overall, this Chancellor recognises the need to increase spending to combat pressures relating to covid, ageing, net-zero, and to support the PM’s levelling up agenda. He also recognises that this will support the economy over the next 2-3 years so is happy to commit to this spending without raising additional taxes in the short-run (i.e., funding through borrowing). But he thinks we must balance the books in the long-term, so has made it one of his rules to fund all additional spending through taxes from 2024-25 onwards and reduce public debt over time. Right now, he’s done that through tax increases, but eventually he wants to achieve higher economic growth to fund this increase in costs, and so wants to be in a position to reduce taxes in the future.”
Now we’re talking, Luc. Tax, that’s what all my clients want to know about. We’ve got a 6% increase in corporation tax in 2023, and NIC rises from 2022. Is there going to be more?
“I’ve no idea, Dad, and I couldn’t tell you if I knew.”
Oh come on, Luc, I did clean you up when you pooed yourself in McDonalds that time many years ago…
“To be honest, I doubt if anyone knows – it will depend on how things go. There’s probably 3 generic factors that determine your tax policy:
- to pay for spending
- Wealth Re-distribution
- To change behaviour (eg carbon taxes, fuel duty)
If you’re looking to achieve the first one (fund spending), you’d have to look at the 3 taxes that contribute the most toward our overall tax take (income tax and NICs, VAT and corporation tax), tweaking anything else isn’t going to raise a huge amount (nowhere near enough to fund the health and social care spending etc). NICs have been increased because it is what’s normally used to fund things like health and social care – i.e., its purpose is that the state helps you insure yourself against old age and ill health (hence the name national insurance), so it works to fund the extra spending in these areas. It has been criticised a bit because it is seen as taking tax off working people and is unpopular as it is the younger working generation paying for services mostly used by the elderly. It’s also less progressive than income tax so hits the lower earners harder. How to extract tax from the population in the fairest way is a big issue in Gov’t and I have no idea where it might go. Lots of advanced countries are in the same position and the IMF tends to favour increasing consumption tax, like VAT, because it is paid by everyone not just workers (but it needs to be managed in a way that doesn’t disproportionately hit the poorest).
Corporation tax in the UK is low internationally, so it could be seen as low hanging fruit – i.e., we can increase it and raise a lot of money and still have a fairly competitive corporation tax rate.”[Me: you’ve taught me a lot today; now I need to educate you a little. As recently as 2007, large companies paid a tax rate of 30%, and small companies 20%. The rate for large companies has dropped to 19%, the same as small companies. In 2023, the rate for all but the very small will be 25% – so large companies are 5% lower than 2007 , but small companies are 6% higher, and the owners are also now paying dividend tax of 8.75%. Can you speak to Rishi about his disdain for small businesses?]
“Dad, you’re starting to rant…….. “
People are talking a lot about Wealth taxes?
“Yes, these taxes are getting a lot of attention but people are yet to find a good design for it. People think these will affect the wealthiest, but they won’t – they will always find ways of hiding wealth and avoiding, because they’re in the best place to move their money around. It would hit middle earners most if its going to raise any decent money, anyone with a house and a pension. “
Make sure that doesn’t happen then, Luc? That’s a lot of our clients, it’ll be very bad for business.
No answer. Okay, let’s talk about interest rates, as I’ve read that lenders are increasing their rates for fixed rate mortgages – interest rates going up will be a disaster, surely?
“Oooh, controversial Dad, not necessarily. For a long time, the central bank (Bank of England) has been given a remit to keep inflation at 2-3% through its interest rate policy, and stability has been achieved with very low interest rates for a long time. But there are 3 main problems:
- You have an anaemic economy (eg cheap loans keep unproductive, highly indebted businesses afloat, you get inter-generational problems where richer people hoard assets which become too expensive for younger people to buy, and savers can’t get anywhere in society because of the low returns)
- If institutions cannot get a good return, they will take more risk, which arguably caused the Financial Crisis in 2008 as bankers and financial institutions took on so much risk and gorged themselves on cheap money
- There’s no wiggle room for the government to respond to crises by adjusting interest rates (which is fairly costless) – when rates are 0.25% there is no scope to reduce interest rates to control the economy. Then in a crisis [Covid] there is little option but to spend money to boost the economy, which increase public debt and will eventually lead to the need to increase taxes.
The last point is important. Reducing interest rates is a low-cost way for a Gov’t to boost the economy. Spending is the alternative, and this carries a high cost.”
So tell me about Debt – the Gov’t has obviously spent a lot during Covid, and continues to do so. Where does the money come from?
“It essentially comes from our own people – the UK population, mainly pension funds and banks who are managing OUR assets. They buy Bonds from the Gov’t and during Covid, these institutions will invest in Gov’t Bonds at very low rates because of the risk profile. There was a time when the interest rate on Gov’t Bonds was NEGATIVE – so institutions were lending money to the Gov’t and paying THEM for the privilege. This was because investments were so volatile, they would rather pay a small interest rate to look after their funds, than risk losing a great deal more.
So debt has risen, but most economists do not see this as problematic as we have low interest rates. Also, all countries are spending and borrowing loads, at cheap rates. This is a very different situation to if you were the only country borrowing and spending – then you would be forced to pay very high interest rates.
This of course might mean that borrowing doesn’t matter, so why should we need to raise taxes? The problem is that a lot of the borrowing the government has done has been funded at varying interest rates rather than fixed rates (through necessity). Similar to a variable tracker or a fixed rate tracker mortgage. This means that when interest rates rise (as many expect them to do soon), the costs of servicing this debt will increase massively and will force the government to pay interest and divert money away from public services like health and education.
As a result, the Chancellor definitely wants to bring debt down in the long run, but doesn’t want to risk increasing taxes and damaging the economy in the short term. After 3 years, he wants to balance ‘Current Spending’ which excludes Investments, and the only additional borrowing would be to fund Investments with long term benefit.”
But what if interest rates rise, which seems to be what is expected?
“Yes, the issue is that public finances are VERY sensitive to interest rate rises. The Gov’t is trying to get ahead of that risk by repairing public finance before it happens.”
So it depends how the economy goes?
“Of course, Dad. It’s interesting to note that just before the Budget, the Gov’t got figures showing that the economy had performed better than expected, and it actually had some funds in the coffers to play with. There was a lot of discussion of whether to bring that into the spending, or save it for a rainy day (e.g. interest rates rising). In the end, the Chancellor decided to take a middle route, spending some to please Boris and saving the rest.
The surplus arose because nobody had any idea at all what would happen with Covid and how the measures would work – the feeling is that the economy held up better than expected.”
What about inflation then? The official figures are around 4% but that just seems ridiculous to me – it feels more like 15%.
“Well, boosting the economy by spending fuels inflation. You’ve also got the problem that Covid is affecting the supply side, which is increasing the pressure on inflation. The Gov’t doesn’t want to contribute to inflationary pressures with its spending which is a factor in deciding where to allocate funds. “
What about the bit you wrote, Luc?
“Dad, I need to go out soon. But just this last question. I wrote Appendix A which is about the re-introduction of fiscal rules. These basically require the Government to operate within certain ratios. Some rules were introduced a while ago, but were abandoned during Covid, and are now being re-introduced, with some modifications, and with some flexibility, given the high levels of uncertainty. The rules are:
- Net debt as % of GDP to be falling after 3 years
- Current budget to be balanced after 3 years
- Public sector investment does not exceed 3% of GDP
- Welfare costs remain sustainable and within a predetermined cap”
Aha, that last bit sounds a bit more Tory?
“The Gov’t feels that there is a good labour market and there should be less state reliance. The Universal Credit taper is all about the fact that as you increase your working hours, you lose Benefit, of 63p in the £, now reduced to 55p, so in the recipient’s favour.”
When you add tax and NIC to the loss of Benefit, this is still a massive disincentive to work and I know people in that very boat.
“Dad, I need to go out, it’s Sunday night……”
So my massive thanks go to Luc for what I found to be a fascinating insight, and I hope I have done justice to your thoughts. I’m very proud of this young lad, of course, who is only just 2 years into his working life – he’s got a pretty exciting job and he’s doing really well, and having a great time in London at the same time.
So what do we take out of all this?
It seems to me that no matter how hard the Gov’t tries to control inflation, it’s going to go up. I don’t believe the figures, in all honesty. Different department to Luc’s. This will lead to increases in interest rates, so we should prepare for that.
I think that the amount of inflation and interest rate rises we get depends on the economy and how well it does. From all the businesses I see, I can see real energy and optimism – things are buzzing, BUT everyone is finding things unbelievably difficult operationally. Supply issues, price issues, logistical issues, labour issues. It’s incredibly difficult to recruit, and also to keep your own staff. To combat all of these things costs money, and I can see how inflationary that is.
I feel there is so much scope for business growth, but operational issues are holding it back. I believe that labour is the starting point. We need to get solve the labour shortage, otherwise we simply won’t have the resource to grow the economy. If we can do that, and things settle down, I hope that the economy can thrive, and inflation can be held at bay, easing pressures on interest rates and taxes.
From a tax point of view, we have some major increases already planned. There may be more, depending on how the economy fares in the next 2 years.