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The UK budget deficit is currently forecast as £394 billion for 2020/20211. A deficit of some degree is entirely normal, but to put this in context, the 2019/2020 deficit was £56 billion. This suggests that the Covid19 pandemic has cost the UK economy £338 billion, a figure which is rising.
There are a number of reasons for this, for example:
- Supporting people unable to work through the furlough scheme
- A higher level of unemployment and sickness benefits
- Financial packages for businesses
- Increased cost of funding the NHS and providing PPE
- Investing in the vaccine
- Reduced tax revenues with more people out of work or unable to work
While the government receives its fair share of criticism for some of the decisions made, the likelihood is that if it had not invested in these things, the situation would be far worse for considerably longer.
The government has also committed to investing in infrastructure and new jobs, all of which come at an initial cost. It is too early for these investments to boost the economy with the urgency needed.
To reduce the deficit, the government needs to raise more money. Increasing taxes is one of the quickest ways to do this.
What Are the Proposals?
The proposals are still at the early stages now, but have been discussed in the press since around December 2020. While no official announcement has been made, it’s possible that the government are trying to gauge public opinion before committing to any firm decisions.
The Wealth Tax Commission is a group of economists who have drawn on multiple international sources to research the most effective way of reducing the deficit. Their conclusions, published towards the end of 2020, suggest that a wealth tax could work as follows:
- The tax would be a one-off event.
- Individuals with a net worth of over £500,000 (or couples with over £1 million) would be taxed at a rate of 5% above the threshold.
- The tax bill could be spread over 5 years, effectively 1% of net wealth per year.
- All assets, including the main residence, pensions, and business assets should contribute towards the net worth calculation. Debts such as mortgages could be deducted.
It has been estimated that the government could raise up to £260 billion by levying this tax. The wealthiest 1/6th of UK households (or around 8 million people) would be affected.
How Would a Wealth Tax Differ from Other Taxes?
There have been discussions around raising existing taxes, but given the pressures already on household finances, this is not likely to gain public favour. The options would be:
It would be possible to increase taxes on salaries, dividends, pensions, and rental income. However, this could affect many people who are already struggling, without significantly increasing tax revenue.
Targeting higher earners would be one possibility, but wealthier people have more options to structure their income and reduce taxes.
Overall, an increase in income tax is likely to be unpopular and probably not as effective as a wealth tax.
Capital Gains Tax (CGT)
CGT can arise when you sell an asset (such as shares or a rental property) for a profit. Reliefs are available for properties you have lived in or business assets.
The issue with CGT is that it only arises on certain events, and the investor is in control. So if the rate of CGT were to increase, it would be easy to avoid it by holding on to assets or selling them over time within the annual exemption. Investors may also be more inclined to use investment bonds, which are not subject to CGT, once they have used their ISA allowance.
Inheritance Tax (IHT)
At first glance, increasing the rate of IHT (or reducing the nil rate band, so that more households pay it) seems like a reasonable solution. It would target the same demographic as the hypothetical wealth tax, but would not require anyone to pay the bill out of their income or sell their assets.
But, with the UK now having passed the unfortunate milestone of 100,000 deaths from Covid19, a tax on death at this point seems distasteful. On a more pragmatic note, it also creates uncertainty over when the tax could be collected.
The original plan was for the rate of Corporation Tax to reduce from 19% to 17%. The government backtracked on this as part of the 2020 Budget due to the increasing costs of the pandemic.
Targeting businesses any further, particularly as so many have suffered over this past year, is unlikely to be practical or politically palatable.
So, with good reasons not to increase any of the existing taxes, a wealth tax could be the solution.
Income vs Wealth
The UK is wildly unequal in terms of income and wealth distribution. Even before the pandemic, the vast majority of households in the UK had disposable income below the ‘mean’ or average. This indicates that the scale, and what is deemed average, was massively skewed by a smaller number of higher earners.
Wealth is even more unevenly distributed. The richest 10% of households owned around 44% of all wealth. The wealth share of the top 0.1% doubled between 1984 and 2013.
People who rely on their salaries, particularly lower earners, bear a higher amount of tax relative to their income. Income tax, National Insurance, Council Tax, vehicle tax and VAT are essential costs for most people, and cut into an average salary.
Wealthier people still pay these taxes, but they do not have the same effect on their standard of living. Additionally, they are better placed to benefit from rising property prices, capital growth, dividend income (which is taxed at a lower rate than earnings) and tax planning options.
A wealth tax would be one way of reducing the level of inequality.
Potential Benefits of a Wealth Tax
Some of the benefits of a wealth tax could be:
- It would not depend on specific events to trigger a tax bill.
- As the tax would be levied on all assets, it would be more difficult to avoid, for example by paying into a pension or investing in a business.
- It would prevent making things more difficult for lower earners.
- The projected tax revenues are substantial and could go a long way towards a more manageable deficit.
- It avoids increasing existing taxes, which could be politically difficult.
- The current suggestion is that a wealth tax would be a one-time event, and therefore not life-changing for the majority of people affected.
Of course, a wealth tax is not a perfect solution. Some potential barriers are:
- The administrative complexity of introducing an entirely new tax regime.
- The question over how assets are valued, particularly property that has been owned for many years or overseas assets.
- The potential for hiding assets. The wealthier the individual, the more options they have. The result of this could be tax avoidance by the very wealthy, with the moderately well-off middle classes bearing more of the cost.
- Many wealthy people are asset-rich and cash-poor. A household with most of their wealth tied up in their home (which would not be difficult in London, for example) may find it difficult to pay an unexpected tax bill.
- Current indications are that a wealth tax would be a one-off, but it is far more likely to be an experiment. Once the infrastructure is in place and the precedent is set, it is easy to see it being implemented again.
What You Can Do
If you think you might be affected, here are some things you can do:
- Don’t panic. A wealth tax has been suggested, but it has not yet been written into law and may never happen.
Consider gifting some money if this was already part of your plan and you can afford it.
- Make use of your tax reliefs, allowances, and exemptions, as this will help to reduce your tax bill overall.
- Make sure assets are split sensibly between spouses. If each individual has their own threshold of £500,000 (rather than a joint allowance of £1 million) it could make sense to divide assets equally. Of course, there are other considerations, such as income tax, dividend allowances and CGT exemptions. It is always worth seeking advice on the most efficient asset split.
- Diversify your investments and make sure you have enough cash available for emergencies.
- Do not be tempted by tax avoidance schemes, particularly if they have been newly introduced to circumvent new rules. HMRC usually finds a way of closing the loopholes, and your eventual tax bill, with interest and penalties, could be even higher.
- If the majority of your wealth is tied up in your home, you may be able to release some capital by re-mortgaging or accessing equity release. Of course, going into debt to pay a tax bill is not ideal, so this should only be considered as a last resort.
- Don’t make any major life decisions without taking advice first.
Please do not hesitate to contact a member of the team to find out more about tax planning. Book a free call with a member of our team today, without obligation. We look forward to speaking with you.
Please note, advice on Tax and Trusts is not regulated by the Financial Conduct Authority