Tax issues in an election year

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15 February 2010

With a general election just round the corner, the main political parties have stepped up their campaigns and inevitably these have focussed on the important issues of public spending and tax and how to address the current budget deficit problem of around £175 billion.

In his pre-Budget report, the Chancellor announced a 50% supertax on bankers' bonuses, to be charged to the employer on top of the individual's tax liability. In political terms it was presented as discouraging excessive risk taking within banks but in reality the tax will affect many other financial institutions and is likely to lead to the top banking and financial talent leaving the UK and continuing to work from a place where their income is not so severely hit by tax. Given that the tax will be levied on the employer, they cannot really be expected to do anything to discourage this behaviour.

Alistair Darling also announced anti-avoidance measures with the aim to protect £5 billion of tax revenue. This caused one of the biggest reactions of the afternoon from the House and is clearly a necessary measure to stop people illegally evading tax but given the size of the deficit, it is not single-handedly going to make much of a difference.

Interestingly, the Chancellor chose to remain silent on the bigger issues such as a possible increase in capital gains tax, VAT and the restriction of certain inheritance tax reliefs. In terms of CGT, maybe this was not wholly surprising as it would have given taxpayers time to accelerate decisions to sell assets before the increase came into force. He will also have been conscious that the last time he announced a CGT change, in the pre-Budget report of 2007, it led to months of hostile exchanges with business groups and to an eventual watering down of the plan.

However, Darling's silence should not lull anyone into a false sense of security. His team has admitted that the yawning gap between the 18% CGT rate and the new 50p top rate of income tax for high earners is creating "strange incentives". Not only will the aim be to boost revenue but it will also deter high earners from declaring income as capital gains. Although many artificial schemes of this sort have been blocked, the increase in income tax rates has already led to many planning techniques being adopted to redirect pay towards capital gains.

A rise in CGT will inevitably be a blow to the City. Many commentators believe that it is the ability of financiers to take some of their profits as lightly-taxed capital which prevents them from leaving the UK but this, along with the supertax on bonuses, may be the final nail in the coffin for them. It would also anger long term investors and entrepreneurs who will be taxed at the same rate as short-term speculators and buy-to-let investors.

It was, of course, the Conservatives who introduced the system whereby capital gains were taxed at the top rate of income tax and this was inherited by Labour who have had to explain the embarrassing anomaly that wealthy individuals pay tax at a lower rate than low earners. The political appeal of increasing CGT stems from it being rarely paid by low earners and an announcement of a change in the pre-election Budget will send out another signal to voters that Labour is intent on creating "fairness" in the tax system.

While any increase in CGT will affect many individuals, in political terms, it will not go a long way to fund the large budget deficit and the question of how this problem is tackled has been posed to all of the main political parties in the run up to the election.

The Conservatives have not ruled out raising taxes (including VAT) to shrink the deficit but historically the party has preferred to control public spending to avoid tax increases. David Cameron has said he intends to cut public spending through a one-year freeze on most public sector workers' pay and to bring forward the planned increase in the state pension age. Aside from these measures, the Conservatives have yet to provide details on how they plan to cut public expenditure. Whilst declaring their commitment to the NHS, they have not been prepared to give voters "cast iron" promises on individual taxes, although they have reaffirmed their intention to cut inheritance tax.

Labour have been equally reluctant to explain in exactly which areas they plan to reduce public spending. In the pre-Budget report, Alistair Darling announced belt-tightening measures including a 1% cap on public sector pay rises and an increase in National Insurance from 2011 but surely more drastic cuts need to be made in order to make an real impact on the size of the deficit. And given that inheritance tax accounts for only £5 billion of revenue, the announcement that the nil rate band (the amount above which IHT is charged) is to be frozen at £325,000 instead of the planned increase to £350,000, is not going to be the answer to their problems. Instead, it will lead to yet more middle-income people falling within the inheritance tax net which was initially introduced to catch only the very wealthy.

All of this has left the Liberal Democrat leader Nick Clegg being able to say pretty confidently that neither Labour nor the Conservatives have a convincing plan to improve the state of the UK's finances. As things stand this does not look too far off the truth, or if either party does have a plan it is unlikely to be revealed until they are safely on the other side of the general election.

If you would like further information please contact Clare Henderson on +44(0) 117 307 6858 or by e-mail on clare.henderson@burges-salmon.com or Tom Hewitt on +44(0) 117 902 2717 or by e-mail on tom.hewitt@burges-salmon.com

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