With just two days to go until Chancellor Jeremy Hunt announces his Autumn statement, rumours have been swirling that cuts to public spending, tax increases and threshold freezes could all be on the cards.
Following severe market volatility, culminating in the resignation of former Prime Minister Liz Truss, Chancellor of the Exchequer Jeremy Hunt will be under growing pressure to repair the country’s economic credibility while plugging the gap in public finances.
We look at some of the changes that could emerge when Hunt unveils his statement on 17 November an the potential effect on financial plans. In order: Income tax, CGT, IHT, dividend tax, social care cap, pensions lifetime allowance, annual allowance, pensions triple lock, pensions tax relief, money purchase annual allowance, energy company windfall tax.
Income Tax Changes
Former Prime Minister Liz Truss’ decision to lower taxes for higher earners in her September “mini-Budget” was met with uproar across the country.
Prime Minister Rishi Sunak and Hunt may therefore view changing the top rate of income tax and lowering the additional tax rate threshold as a “relatively safe option” to boost government tax revenue while proving inconsequential or popular with the general public, says Shaun Moore, chartered financial planner at Quilter.
Freezing income tax thresholds may also be on the cards. Thresholds are currently due to remain frozen until 2026 but with the cost-of-living crisis weighing heavily on government spending, there is speculation that these could be extended.
Calculations by Quilter show that if wage growth is on average 5% a year over the next five years but income tax thresholds remain frozen, someone earning £35,000 today will be £695 worse off in the 28/29 tax year and cumulatively £2,016 poorer over the five-year period. Similarly, someone earning £50,000 today will be £3,403 worse off in the 28/29 tax year and £9,765 poorer over the five-year period.
Moore said: “These calculations illustrate the power of fiscal drag and how freezing income tax thresholds is a form of stealth tax. Ultimately, if thresholds remain frozen for a number of years then you will end up paying considerably more tax.”
Laura Suter, head of personal finance at AJ Bell, commented: “Stealth tax freezes generate far fewer negative headlines than hiking tax rates or lowering thresholds, so it’s understandable that the new chancellor looks to be eyeing up a huge swathe of them. The added bonus is that the new prime minister can also claim he hasn’t broken election promises of raising taxes. Rishi Sunak already announced tax threshold freezes until 2026, but in a bid to improve the longer-term finances of the country he could be set to extend this until 2028.
“The government is banking on the fact that the average taxpayer doesn’t fully understand the financial impact of freezing allowances, and so hoping the move slips under the radar of many. But the combination of frozen allowances and soaring inflation is toxic for people’s finances. Most workers aren’t getting a pay rise that keeps up with the rate of rising prices, and then more of the pay rise they do get will be gobbled up by tax.”
Capital Gains Tax
According to Moore, tinkering with CGT might be an option for the Chancellor as it is only paid by the minority.
Moore said two potential options are reducing the CGT exempt amount or aligning CGT rates to income tax.
Moore said: “Of the two options, aligning the bands is most lucrative for the treasury. If rates were increased, they would go from 10 to 20% for basic rate taxpayers and 20 to 40 or even 45% for higher and additional rate taxpayers. The alignment of rates would mean they at least double for all tax bands. Whilst it is hard to say the exact amount of revenue this would secure; you could go so far as estimating twice the tax take – currently circa £14bn. As always, it isn’t that simple, some pay a reduced rate of 10% on business assets and some pay the 8% surcharge on property already, but it could easily bring in significant amounts.”
Suter said a less radical move would be for the government to cut the tax-free allowance from its current £12,300. Cutting it in half to £6,000 would generate £480 million, while reducing it to £2,500 would give the government an extra £835 million.
Inheritance Tax Charges
Extending the current freeze on Inheritance Tax thresholds for an extra two years would net an additional £1 billon for government coffers, with the sharp rise in house prices resulting in a growing number of people falling into the IHT net.
Moore said: “The government are stuck between a rock and a hard place at the moment as they continue to have to cope with the significant debt they took on to cope with the pandemic but also now have the unenviable job of needing to help alleviate a cost-of-living crisis. Extending the frozen thresholds for an additional two years is an inheritance tax raid by stealth.
“While house prices may soon cool due to the never-ending list of financial concerns facing the UK such as inflation, energy prices and an unpredictable European war, this is unlikely to take the sting out of IHT bills for some time.”
Extending the freeze from 2026 until 2028 will mean that the £325,000 tax-free allowance will be unchanged for almost two decades, despite house prices and other asset prices rising dramatically in that time. This is reflected in the government’s tax take, with £6.1 billion paid in IHT in the past year, up more than £700 million on the previous year.
Gifting allowances have also not increased with inflation, reducing people’s options for mitigating IHT. If the government does choose to freeze IHT thresholds, Quilter believes they should consider increasing the gifting allowance, which would help take the sting out of the financial hardship many are facing.
Dividend Tax Changes
Dividend tax was due to be cut from April next year, with the former Chancellor promising that the rate would be reduced and the additional rate abolished altogether. However, AJ Bell said this could change.
Suter said: “Any changes to dividend rates would affect the 2.6 million investors and company directors who pay tax on their dividends. But a move to cut the tax-free allowance would affect more people, who currently don’t pay any tax on their dividends because their annual pay-outs are within the limit.”
Suter said one option could be to raise rates. The previous 1.25 percentage point hike was expected to generate £1.4 billion for the government, so another increase by 1% would raise a similar amount. The move would also bring dividend tax rates closer to income tax rates for higher and additional rate payers.
Another option would be to cut or scrap entirely the £2,000 tax-free allowance for dividends.
“Scrapping it entirely would mean lots of people earning very little in dividends would have to file a tax return, meaning the administration would likely cost more than the tax take for those taxpayers. A more workable option would be cutting the allowance to £1,000 or £500.
The move would not be popular. Investors and company directors getting dividend payments have faced a continual hike in tax over the past six years with rates being increased and the tax-free allowance having been slashed already,” said Suter.
Social Care Cap
There has been growing speculation that the government’s social care cap could be delayed or even scrapped altogether. Following years of debate and pontification, the government proposed an £86,000 cap.
However, as a result of the pandemic leaving a black hole in the public finances and the country facing a severe cost-of-living crisis, delaying or abolishing the cap would save the government a considerable amount.
Pensions Lifetime Allowance
Further changes to the pensions lifetime allowance could be on the horizon but the suggestion has been met with fierce criticism from the pension industry, who argue that tinkering with the rules would add more complexity to the retirement planning process. The allowance has moved around considerably since its introduction in 2006 and many are expecting an additional two years to now be added to the freeze.
The allowance was originally set at £1.5 million as part of a plan to simplify pensions, setting a single number that established the maximum someone could build their pension to tax-efficiently. In 2015, it was announced that the lifetime allowance would be cut from £1.25 million to £1 million from 2016/17 and tied to CPI from April 2018/19. As it currently stands, the allowance has been de-linked with inflation and is frozen at £1,073,100 until 2026.
Jon Greer, head of retirement policy at Quilter, said: “Our analysis, based on previous Treasury forecasts, shows a two-year extension would see pensioners hand over at least an extra £400 million in tax, on top of the £990 million forecast to be raised by the five year freeze announced in March 2021.
“Some will argue that freezing the LTA by an additional two years is justified because pensioners haven’t been as adversely affected financially in the past couple of years in comparison to those of working age, and so they must pay their fair share of the costs.
“However, what this view fails to appreciate is that the lifetime allowance is a test on entry into being a pensioner. Someone who became a pensioner before the onset of the pandemic and the cost-of-living crisis seen in the past couple of years isn’t going to face a lower LTA if their pension is already 100% crystalised and they are withdrawing an income. Freezing the LTA will mostly impact people in the workforce today who are forced into retirement because they lose their job.”
Doctors will be among those hardest hit by the change and the NHS could suffer as a consequence as doctors may be encouraged to accelerate their retirement plans, warned Greer.
“Should the freeze be extended as is widely expected, this scenario could begin to play out quite rapidly and the already rather complicated process of retirement planning will be made that bit more difficult,” he added.
Annual Allowance
AJ Bell said the government may consider reducing the pensions annual allowance, which currently stands at £40,000 and controls the total value of tax-incentivised contributions that can made to a pension each tax year.
Tom Selby, head of retirement policy at AJ Bell, said: “Such a move would be less seismic than ditching higher-rate relief but would not be without problems or controversy. Once again, the big sticking point will likely relate to defined benefit schemes – and specifically the NHS scheme.
“The British Medical Association has previously warned the spike in inflation we have seen this year could lead to NHS practitioners being hit with pension tax charges running into tens of thousands of pounds – and that is assuming the annual allowance remains at £40,000.
“If the annual allowance is cut, there will clearly be a risk of more early retirements, placing further strain on the NHS.”
Pensions Triple Lock
It is likely that Sunak and Hunt will be considering whether they can honour their party manifesto promise of keeping the triple lock in place or opt to increase the state pension by a different measure in the face of a difficult economic outlook.
The triple-lock guarantees the state pension increases each year in line with the highest of average earnings, CPI inflation or 2.5%.
Pension specialists agree it will be expensive to keep in place for April 2023 given it is set by the September 2022 inflation figure of 10.1%. This will lead to the full flat-rate state pension increasing from £185.15 per week to £203.85 per week in April next year. The basic state pension will increase from £141.85 per week to £156.20 per week.
However, the triple lock may prove less expensive to keep in place from 2024 onwards with the Bank of England predicting inflation may drop to 7.9% by the third quarter of next year.
Greer said: “Pensioners across the country will be eagerly awaiting the budget with hope that the previous commitment to the triple lock will be honoured, particularly given the low increase of 3.1% they received in April 2022 when inflation was already around 9%.
“The triple lock is proving to be a political hot potato for the government, and Sunak will need to make a final decision either way by the autumn statement deadline to help pensioners plan for their finances, particularly at a time when inflation continues to soar and finances are so front of mind.
“Regardless of the outcome, the triple lock does not work for everyone, and perhaps it may be time to assess whether there is a fairer way to raise the state pension while preventing more people slipping into the poverty net and having to choose between heating or eating.”
Pensions Tax Relief
A further area that Hunt could look to is pensions tax relief, with the main focus falling on higher and additional rate taxpayers.
There has been speculation that the government could cut the rate for higher rate taxpayers in half from 40% to 20%, introducing a lower flat rate to match the current rate for basic rate taxpayers. This could raise an additional £8 billion to £10 billion each year which could go a long way to helping the government balance the books.
Selby said: “It has become something of a tradition for rumours to emanate from the Treasury about its imminent demise. This is perhaps inevitable given the total net cost of pension tax and national insurance relief was estimated at close to £50 billion in 2020/21.
“While successive chancellors have chipped away at pension tax allowances, higher-rate relief has remained untouched, despite estimates scrapping it could deliver an annual saving of around £10 billion. There are plenty of reasons why this might be the case. Most obviously, scrapping higher-rate pension tax relief would hit middle England directly in the pocket – a section of society the Conservative Party can ill afford to alienate.
“Automatic enrolment also remains relatively fragile – particularly given millions are facing a cost-of-living squeeze – and there may be concerns scrapping higher-rate relief could spur a rise in opt-outs.”
Money Purchase Annual Allowance
Changing the rules around the Money Purchase Annual Allowance could give the government an opportunity to offer something positive to the general public. Current rules mean that people taking income flexibly from their pension could see future contributions capped at just £4,000 per year rather than the normal £40,000. With a growing number of people accessing their pensions amid the cost-of-living crisis, there is a risk that they will be prevented from recovering those funds when their finances are in better shape.
Greer said: “We believe the Chancellor should relax the MPAA triggers for at least the current tax year in order to avoid this double-whammy for people forced to use pension cash in the crisis.
“According to the ABI, someone in their 50s on average earnings would only have to pay an extra £151 a month into their pension above the minimum required to exceed the MPAA. Paying more than £4,000 a year would mean having tax relief clawed back. This effectively punishes people trying to do the right thing and severely limits their ability to save for retirement in the future. It’s high time this inflexible rule was scrapped in favour of a general anti-abuse approach similar to that taken for existing pension tax free cash recycling rules, which gets to the crux of HM Treasury’s concerns.”
Energy Company Windfall Tax
With energy giants enjoying record prices while people struggle to find the money to pay their energy bills, windfall taxes are likely to be a popular option on the face of it. However, AJ Bell’s financial analyst Danni Hewson said the Chancellor will need to “pick his way carefully across a tightrope that’s slicked with some of the black stuff at the heart of the debate.”
Hewson said: “BP has already handed over millions thanks to the energy profits levy but so far Shell has neatly avoided the tax by instead investing in North Sea oil and gas projects which triggered an offset in the form of investment relief, though it has written down hundreds of millions it expects to pay in the first quarter of next year.
“Making more changes after the terms of the deal have been agreed won’t sit well with businesses. If they can’t trust the UK government to play by the rules it sets, they might look elsewhere to ply their trade – it’s not as if these aren’t multi-national companies with plenty of nations clamouring for their patronage. Extending it to electricity generators is also back on the table with discussions about a cap on the renewables sector to stop them cashing in on surging wholesale prices which are linked to gas prices.”
Hewson added: “Quick wins might score points with voters and they might help fill that gaping hole in the public finances, but they can have other, unexpected consequences. The energy sector needs fundamental and sustainable changes and that will require good will and good amounts of cash. But the cost-of-living crisis is focussing minds and the government knows it needs to win over hearts as well.”
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