How will we pay it back?
How many of us had used the word ‘furlough’ before March, or even knew what it meant? And who could have predicted that HMRC would have allowed you to defer VAT and self-assessment liabilities until next year – interest- and penalty-free? Well, these government help schemes, along with many others as well, now represent the ‘new normal’.
The level of government-funded economic support for individuals and businesses is truly unprecedented. But so too is the cost. The Office for Budget Responsibility estimates that the government deficit – the difference between government spending and receipts (i.e. tax) – will soar to over £300 billion in the current financial year. Government borrowing in April was higher than for the whole of 2019.¹ Understandably, there’s more than a modicum of interest in how the government is going to fill that hole.
Other than through taxation, the government raises money chiefly through the sale of gilts – borrowing money from the market with the promise to pay interest and repay the capital at the end of the term. Here too, we are in uncharted waters, as the government recently issued £3.8 billion in gilts on a negative yield, for the first time ever. This means investors who hold the debt to maturity will get back less in interest payments and capital than they paid.
For now, the government only needs to worry about funding the interest costs on this new borrowing, and it’s helpful therefore that rates are so low. But how about the repayment of the capital in future? In the past, inflation has proved effective in reducing the real value of government debt, but that seems unlikely to help in the near term at least. And, of course, higher inflation presents its own economic challenges.
Repaying the debt
As individuals, we naturally think first of repaying personal debt out of income. It’s not unreasonable to think this way too in relation to the government’s liability. And for the government, ‘income’ largely means taxation. Taxation is a function of many factors: the level of economic activity (that generates tax liabilities); the tax rate; the number of people and businesses paying tax, and the number of activities and assets subject to tax; the cost of collection; and the extent to which avoidance and evasion is minimised.
The problem for the government is that the economic stagnation will hit its tax receipts hard. It’s for that reason that talk has turned inevitability to the likelihood of future tax rises to help repay the debt pile; more so given the government’s reluctance to return to austerity or impose major public spending cuts.
Income Tax, National Insurance and VAT are the biggest personal tax fund-raisers, generating over a quarter of annual tax revenue; yet the government’s immediate problem is its election promise not to increase any of them. But even if it reneged on its promise, a one penny rise across all tax rates would raise less than £6 billion a year.²
Increasing VAT could backfire by having a negative impact on demand – not ideal when we are looking to reignite the economy to generate revenue.
What seems more likely is some structural reform to the way tax and National Insurance is applied to businesses, especially the self-employed.
Another risk for the government is that excessive tax rises simply encourage more people to avoid tax or just leave the country, further reducing the amount of money collected.
Tax relief on pension contributions costs the government around £40 billion a year³, and there has been speculation about possible changes for many years. Removing higher rate tax relief and introducing a lower flat rate of relief could certainly generate additional tax revenue.
Reforms to some aspects of Capital Gains Tax have been put forward over the years; for example, taxing gains in the same way as income, and removing the rebasing of assets to wipe out taxable gains on death.
Inheritance Tax changes have also been proposed by the Office of Tax Simplification and the All-Party Parliamentary Group on Inheritance and Intergenerational Fairness. A change at some point seems likely but, given that Inheritance Tax generates around £5-6 billion a year⁴, even doubling that, it would take many years to make a dent in the government’s debt. That doesn’t mean change won’t happen, though.
Corporation Tax appears to offer little scope. It generates just under £50 billion per annum and the government rowed back on plans to cut the rate from 19% to 17% in April.⁵ It will also have in mind the need to present the UK as an attractive destination for businesses – especially post-Brexit.
The introduction of some new taxes has also been suggested. A windfall tax on businesses that have thrived during the crisis, such as food and online retailers, is one example which appears to have public support.
Another is a one-off or continuing form of wealth tax. Manchester Metropolitan University’s Future Economies Research Centre estimates that a one-off 2.5% levy on all UK personal wealth (including property net of mortgage, financial assets, savings and pensions) would yield over £350 billion – job done! Clearly, though, this is not without problems – politically and practically – the valuation of assets and the challenges of liquidity to pay the levy are two that immediately spring to mind.
In short, a combination of some tax rises, some smart spending decisions, and economic stimulus seems the most likely strategy. We expect another Budget in the autumn, although the chancellor’s tax and expenditure plans will only become clearer (and rightly so) once we see the shape of the hoped-for economic recovery.
In the meantime – and closer to home – the need for, and value of, expert tax-planning advice has never been greater.
¹ Office for Budget Responsibility, May 2020
², ³, ⁴, ⁵ HMRC Tax & NIC Receipts, April 2020
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.