Money

Where will Labour find £22bn?

Published

3 days ago

September 16, 2024

As the UK government grapples with a £22bn fiscal deficit, chancellor Rachel Reeves is faced with the daunting task of filling this financial void without resorting to increases in VAT, income tax or National Insurance (NI).

With these traditional tools now off the table, the government will be considering a range of less conventional and potentially controversial measures to raise the revenue, with reforms to capital gains tax (CGT), pension tax relief, inheritance tax (IHT) and a wealth tax all reportedly under consideration.

CGT reform

CGT is currently levied at a lower rate than income tax, leading to calls for alignment between the two.

Proponents argue taxing capital gains at the same rate as income would create a fairer tax system. However, this approach has its challenges. Since capital gains accumulate over several years, a sudden hike to the tax rate will be seen as punitive, particularly for those who have held assets for a long time.

A possible solution could involve reintroducing a tapered relief system, where the effective tax rate on capital gains decreases the longer an asset is held, balancing fairness with the encouragement of long-term investment.

Pension tax relief reform

Another potential revenue-raising measure is the introduction of a flat rate of pension tax relief.

Currently, pension tax relief is tied to an individual’s marginal income tax rate, with higher earners benefiting more. A flat rate, perhaps set at 25-30%, would standardise the relief across all income groups, raising revenue and promoting equity.

However, this proposal is fraught with complexities, especially for members of defined benefit schemes common in the public sector. Calculating the value of benefits accrued annually in these schemes is complex and would lead to higher taxes for many public sector workers, including doctors and teachers.

Quite simply, anyone with a marginal tax rate higher than the flat rate for relief purposes will end up getting an annual tax bill to cover the difference. The administrative burden and potential backlash from affected groups make this proposal politically risky and difficult to implement.

It may be that NI relief on employer contributions is viewed as an easier target, although this would load extra costs on the firms the government needs to help drive its growth agenda.

A wealth tax

A wealth tax is another idea being floated as a solution to the fiscal gap. Wealth taxes are not uncommon in Europe, but introducing one in the UK would be a significant challenge.

The primary difficulties lie in defining taxable wealth and the risk of capital flight, as wealthy individuals might relocate to avoid the tax.

Additionally, enforcing a wealth tax would require robust systems to track and value diverse assets, with property and private equity holdings posing obvious challenges.

IHT adjustments

Lastly, increasing IHT is said to be under consideration, but this too is a contentious option.

IHT is deeply unpopular, often seen as double taxation on wealth that has already been taxed as income or capital gains. Raising IHT could also lead to capital flight, with wealthy individuals moving assets offshore to avoid the tax.

Moreover, the revenue potential from IHT is relatively limited due to various exemptions and reliefs.

Politically, increasing IHT could alienate voters, particularly in middle-class constituencies where property values push more families above the threshold. Tinkering with the reliefs available to farmland, private companies and AIM shares would all provoke a vocal reaction from those affected.

In summary, while the UK government will be exploring several avenues to address its significant fiscal shortfall, each comes with its own set of challenges.

CGT reform, pension tax relief changes, a wealth tax and IHT increases all have potential as revenue-generating measures but they also risk political backlash, administrative complexity and economic repercussions.

As the government weighs these options up, the need for careful consideration and balanced policy design is paramount to avoid unintended consequences and ensure any measures implemented are both effective and fair.

And all this needs to be achieved at the same time as the government attempts to promote wealth creation, boost long-term saving and drive long-term economic growth. Squaring that circle will be no easy task.

Andy Bell is co-founder of AJ Bell

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