Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
It’s Budget Day this coming Wednesday, after a brief interlude without one in 2020. On the face of it, the challenge presented to the Chancellor is great, with the gap in Britain’s finances having ballooned over the past year and a complete economic recovery from the pandemic still to be secured.
To quickly recap, following additional government spending of around £250 billion since March 2020, the Office for Budget Responsibility said in November that it expects the UK’s budget deficit to swell to almost £400 billion this financial year¹.
To put that into some sort of context, government borrowing is now at its highest as a proportion of national income compared with any time since World War II. The deficit may also remain greater than £100 billion per annum out as far as 2025-26².
On the upside, ultra low interest rates mean the government can still borrow very cheaply. That provides some sort of window during which the government can continue to spend to secure a stronger economy before fully addressing the big hole in the nation’s finances with tax rises.
Tax rises are fraught with danger at any time, because of the unintended consequences they can have in terms of disincentivising workers, entrepreneurs, consumers and investors. It is though an especially important consideration when the economy is fragile, and the phasing out of measures to support workers and businesses are due to appear on the horizon.
For this reason, any tax initiatives the Chancellor signals next week are most likely to involve some “tinkering around the edges”, for want of a better phrase. Announcements of big tax increases likely to have a transformational impact are less likely at this stage than those that might have a more modest effect.
Medium term, the Institute for Fiscal Studies (IFS) sees a need for net tax rises of something of the order of £60 billion per annum to balance the nation’s books³. That largely remains a question for future budgets, not this one. Even so, and given recent speculation in the press and elsewhere, investors, among others, may be left wondering what’s safe and what’s not?
Given the chatter last week and in line with recent talk of planned changes in the US under a Biden administration, corporation tax could be among the first to see a change. Companies rather than individuals bearing at least some of the brunt has political advantages and could well be viewed as a least bad option among Conservative MPs.
A rise in corporation tax also has the advantage of placing the onus on companies making profits while omitting, for now, businesses making losses due to the pandemic. The corporation tax rate is currently 19%, meaning the Chancellor has scope to raise it while still keeping Britain competitive.
The top corporate tax rate in the OECD and across the countries making up the G7 is approximately 24%⁴.
The effects of a modest rise in corporation tax ought to be minimal from the point of view of investors in UK companies. The prospects for share prices this year and for the foreseeable future are overwhelmingly more likely to be intertwined with how well the economy grows in the aftermath of the pandemic, interest rates staying low and the valuation of the stock market in relation to gilts.
Other potential changes to the investing landscape – for example, cutting the tax relief on private pension contributions or even introducing a wealth tax – seem less likely. They would be unpopular among members of the government and their supporters and it’s hard to see how they might be justified given the economic risks still at large.
Reducing the tax relief available on pensions contributions would be a particularly bad idea in a world where private provisions will be called upon to make an increasingly large contribution to the financing of old age, and the government knows this. A recent report from the IFS showed there is still a mountain to climb with, for example, only 16% of the self employed making contributions to a private pension in 2018⁵.
Harmonising capital gains tax with income taxes has long been mooted as a possibility, all the more so after the Chancellor commissioned the Office of Tax Simplification to investigate the idea last year. Given that the top rate of income tax is 45%, higher earning investors and company owners could face a significant increase in their tax liabilities if this goes through (capital gains tax is currently set at 20% on assets for higher and additional rate taxpayers; 10% for basic rate taxpayers).
The downside for the government, and potential reason for sidestepping this measure is that it would potentially act as a disincentive to company owners and entrepreneurs, who might then opt to establish their next business venture overseas. That would be precisely the opposite of what the government wants as it embarks on a post-Brexit push to attract new businesses to Britain. A halfway house measure, whereby CGT moves closer to income tax rates without meeting them, is of course a possibility.
On balance, it seems likely that the vast majority of investors will emerge minimally affected by the events of next week. However, the Budget does come as an (almost) annual reminder of the good sense in making the most of the tax-free investment limits currently available. With just over a month to go to the end of this tax year, it is worth making sure that you’ve taken full advantage of all the ISA and SIPP (personal pension) allowances you were planning to in 2020-21.
¹ʼ ² Office for Budget Responsibility, 25.11.20
³ʼ ⁵ Institute for Fiscal Studies, 16.02.21
⁴ Tax Foundation, 09.12.20
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. 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 a Fidelity adviser or an authorised financial adviser of your choice.