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As Harry Truman and Gordon Gekko both said, if you want a friend get a dog. Rachel Reeves is discovering that whatever she does in the run up to her difficult Budget at the end of the month, it’s going to annoy someone. But then, if you crave popularity, you shouldn’t become Chancellor.
Falling out with pensioners and some of her own backbenchers over the winter fuel allowance is one thing. She can live without a Christmas card from the parents of private school pupils. And she’ll make her peace with frosty non-doms and private equity bosses. But in recent weeks she’s started to test a more formidable foe - the bond market.
When you are working out how to fill a £22bn ‘black hole’, the last thing you want to lose is the ‘kindness of strangers’, as Mark Carney described the willingness of overseas investors to lend to the UK government. But a rise in the yield on the 10-year Gilt from 3.75% to 4.2% in less than a month suggests relations with fixed income are fraying.
Investors are demanding more compensation for lending to the UK government than to the US. And the government is now paying nearly 2 percentage points more than Germany to borrow for 10 years. Yields are back where they were on election day despite the downward turn in the global interest rate cycle.
Part of the rise in the government’s borrowing costs is just bad luck, or ‘events’ as Harold Macmillan preferred to call it. The stickiness of service sector inflation and wage costs predate the Chancellor’s influence. And she’s not responsible for the overshoot in public borrowing so far this year, nor the greater apparent willingness of the Fed and ECB to cut rates than the Bank of England.
But plans to rewrite the borrowing rules that have kept governments in check since the late 1990s are in her gift. And with them, the expectation that gilt issuance will be higher than forecast, starting in the current year to next March.
Changing the definition of public sector net debt to facilitate more borrowing risks yields pushing higher still if it is not handled well. Increased debt for investment would not only impact the overall borrowing constraint the government had said it would live with but would have an influence on the current budget rule too via extra interest costs.
Thus far, the bond vigilantes have given the new government the benefit of the doubt, but they are saddled up and circling.
The need to rework the UK’s fiscal framework, and so test the patience of the bond market, is a consequence of the Chancellor having painted herself into a corner ahead of the election. It’s easy to see why she did this; she needed to persuade us that Labour could be trusted with the economy. Reeves quite rightly didn’t want anyone to confuse her desire to reverse years of underinvestment with Liz Truss’s unfunded tax cuts. But in doing so she has tied her hands.
Ruling out increases in the big four tax revenue earners - income tax, VAT, national insurance and corporation tax - has made filling the fiscal shortfall unnecessarily difficult. The lowest hanging fruit have been put out of reach.
The taxes she will now have to rely on to supplement what extra borrowing the bond market will allow her are arguably not up to the job without significant unintended consequences. One by one, we are seeing the government row back on plans that started out looking attractive but appeared less achievable on further inspection.
So, the squeeze on non-doms is being watered down. Private equity bosses are likely to be spared the top rate of income tax on carried interest. VAT on school fees may be delayed.
Which leaves a list of potential tax hikes on people who would not consider themselves fair game, or even particularly wealthy. The squeezed middle is once again likely to have to pick up the tab. Raising money through raids on pension saving, capital gains and inheritance will diminish the Chancellor’s fan base yet further if the questions from our investors are any guide.
Ordinary people, trying to do the right thing for their retirements and their families, are deeply concerned about what 30 October will bring. Perhaps most worryingly, there is anecdotal evidence that they are acting in anticipation of changes that may never happen in ways that may be bad for their financial security.
Not only will many of the mooted tax raids be deeply unpopular, they also risk being ineffective or difficult to implement. Take the much-speculated assault on one of the best reasons to invest in a pension - the ability to withdraw 25% of your pot tax-free up to £268,275. While a rational case can be made for limiting this perk to a smaller amount, say £100,000, many people have made prudent financial plans, such as paying off a mortgage, on the basis that it will continue to be available.
There are similar flaws with other potential changes to the tax treatment of pensions. A flat rate of relief on contributions sounds superficially compelling, and could be dressed up as an enhancement to basic rate taxpayers if it were pitched at the right level, but it would have a far-reaching impact on many middle-ranking public sector workers. Increasing national insurance on employer contributions would also not be as victimless as it sounds. The cost would inevitably be passed on to employees.
Budgets often turn out to be less consequential than the speculation in the run up to the statement would suggest. There’s a good reason for that. Many chancellors before Rachel Reeves have road-tested tax changes before, at the last minute, filing them in the ‘too difficult’ tray. Maybe we’ll be spared again, but I’m less confident than usual. In which case, the Chancellor may be on the lookout for a friendly pet.
This article was originally published in The Telegraph.
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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