What COVID-19 means for the future of tax

This article features in the May 2021 edition of TAXline, ICAEW Tax Faculty’s monthly magazine. One article is freely available each month.

With the pandemic increasing pressure on public finances, could this prompt overdue discussions on tax reform? ICAEW’s Head of Tax Frank Haskew and independent adviser Martin Wheatcroft reflect on recent announcements and challenges facing the Chancellor.

With the UK’s deficit set to increase to £2.5tn by 2023, the fact that tax revenues do not cover public spending is starker than ever. However, the problem of balancing the books far predates COVID-19

An aging population coupled with funding and tax administrative decisions made many decades ago have meant that the gap has been slowly but inexorably widening. Frank Haskew, Head of Tax at ICAEW, says: “Since the turn of the century, we have been running deficits almost every year. The fact is that we’re not raising enough tax meet to our day-to-day spending commitments.”

Martin Wheatcroft, an independent adviser and author on public finances who works closely with ICAEW, explains: “People are living longer which is a good thing, but it has a financial impact. For example, the NHS spends an average of £80 a month on 18-year-olds, while for 80-year-olds that cost is more than £500. The perennial issue is that we don’t have a clear long-term strategy for how the government, or any government, plans to deal with that.”

To balance the books, the primary strategy of governments has been to grow the economy and have a moderate level of inflation to inflate away debt. However, financial crises and recessions have meant that in the past decade growth has been a lot weaker than expected. George Osborne, for example, was forced to leave the Exchequer without fulfilling his pledge of eliminating the deficit due to the underperformance of the economy. “When you combine the demographic pressures with slower economic growth then it’s a difficult situation,” says Wheatcroft.

Paying for coronavirus

Into this strained situation enters a global pandemic and its huge financial repercussions. Alongside the severe and prolonged impact on economic activity, stimulus and support packages are expected to add between £0.5tn–£1tn onto UK debt in the next few years. 

Ahead of the Budget in March, the expectation was that the Chancellor would be looking for ways to raise revenues to help cover the costs of COVID. However, the measures announced will not do so – in the short term at least.

“It’s fair to say that there was no serious attempt to tackle a growing fiscal deficit in the Red Book,” says Haskew. “The 2019 manifesto pledge that there would be no rise in VATincome tax or national insurance means that the Chancellor is prevented from the most obvious, and quick, ways in which to raise revenues.”

The flagship measure for revenue raising in the Budget was the increase to corporation tax rates. However, as the change will not come into effect until 2023, this will not provide a quick cash injection. Haskew also argues that the fiscal impact may not be significant. “The potential corporation tax revenues over the forecast period are pretty much balanced by the cost of the super deduction. In overall terms any difference is probably loose change,” he says.

Wheatcroft believes the measure gives an indication of the government’s medium-term plans. “One of the more positive things you can do in the medium term to get your public finances under control is encourage stronger economic growth. By taking action on corporation tax the government wants to try and at least stabilise the situation.” 

Reallocating spending

Evidence for where the Chancellor is securing finance in the short term can be seen in the integrated defence review published on 16 March, which confirmed that the size of the army would be further reduced by 2025. “Since the 1950s the UK has cut defence spend from 10% of GDP down to 2%. Reallocating that finance to healthcare that has helped successive governments avoid increasing taxes,” explains Wheatcroft. “However, with defence spend now just above the NATO minimum, there’s no further capacity and taxes are going to have to go up at some point.” 

Haskew agrees: “The measures announced so far are just nibbling at the edges of the problem. The UK has a strategic question as to whether it tackles the deficit and if so how. Since the start of the pandemic there’s been suggestions from some commentators that capital gains tax and inheritance tax might rise, and other have proposed wealth taxes, but we saw none of those suggestions in the Budget. It shows just how hard it is to raise taxes.”

The need for change

There are a number of areas of the UK tax system that have been ripe for reform for many years, including the differences between the taxation of the employed and self-employed. “We’ve had a position of significant difference between these two types of taxpayer for 20 years and more. Successive governments, of every political hue, have identified it as a concern but never successfully addressed it,” says Haskew. 

He cites Philip Hammond’s attempt to make relatively modest changes to national insurance contributions for the self-employed in 2017, which were reversed within a week. 

Wheatcroft, meanwhile, points to the perennial thorny issue of business rates and the interim review published as part of HM Treasury’s Tax Day announcements on 23 March. “Everybody was in total agreement that it’s a bad tax and needs reform, but they were also very unhappy about the main alternative option,” he says. “There’s definitely an inertia bias when it comes to changing taxes because it is so difficult. It’s much easier to stay with the current ones, simply because they already exist and they are collecting revenue, however imperfectly.”

Haskew agrees: “These cases highlight that a lot of the structural problems in the tax system have become so ingrained that trying to change them is almost impossible.”

Catalyst for reform

Decisions on how to balance the books have been getting increasingly difficult year on year, but could the dramatic impact of the pandemic provide the impetus for the government to set out a long-term vision of how to tackle the deficit and for Rishi Sunak to make some brave choices?

“From a public support point of view, this past Budget was politically the best possible time to raise taxes, with everyone understanding the financial impact of the interventions that the government has had to take,” says Wheatcroft. “However, from an economic perspective it would be the worst time. At the moment the government wants to do everything possible to encourage a strong economic recovery. This is probably why the government took the opportunity to pre-announce raising corporation tax rates now, rather in three years’ time immediately prior to a general election.”

Wheatcroft suggests that the Chancellor has potentially another 12 months of political goodwill in which to implement changes and suggests that Tax Day is a good indication of travel. “The very fact of having a Tax Day announcing the consultations and setting out a 10-year strategy, which it did last year, is a positive sign of longer-term thinking,” he says.

Haskew believes that now is the time to start having a national conversation about the future of tax and cites a Treasury Committee report, Tax after coronavirus, published on 1 March as a step in the right direction. “It’s a really interesting report because there was a consensus among the cross-party members about proposals to try and address some of these issues,” he says. 

“The deficit and tax reform are more than political issue, so reaching a consensus was really encouraging,” he says. “We have this growing problem as a nation, so what are we going to do about it? These things need to be debated, to see whether we can reach some consensus about the best way of raising tax without harming productivity.”

This article was originally published by ICAEW.

Fiscal deficit on course to exceed £300bn in 2020-21

The UK reported a £19.1bn fiscal deficit in February 2021, bringing the total shortfall over eleven months to £278.8bn. Public sector net debt is up by £333.0bn at £2.13tn.

The latest public sector finances released on Friday 19 March reported a deficit of £19.1bn for February 2021, as COVID-related spending continued to weigh on the public finances. This brought the cumulative deficit for the first eleven months of the financial year to £278.8bn, £228.2bn more than the £50.6bn reported for the same period last year.

The reported deficit for the eleven months excludes £27.2bn in potential business loan write-offs that the Office for Budget Responsibility (OBR) has included in its forecast deficit of £354.6bn for the full financial year.

Falls in VAT, corporation tax and income tax receipts and the waiver of business rates were the principal driver of lower tax revenues over the last eleven months, while large-scale fiscal interventions have resulted in much higher levels of expenditure. Net investment is greater than last year (mostly as planned), while the interest line has benefited from ultra-low interest rates.

Public sector net debt increased to £2,131.2bn or 97.5% of GDP, an increase of £333.0bn from the start of the financial year and £347.2bn higher than in February 2020. This reflects £54.2bn of additional borrowing over and above the deficit, much of which has been used to fund coronavirus loans to businesses and tax deferral measures.

The cash outflow (the ‘public sector net cash requirement’) for the month was £11.4bn, increasing the cumulative total cash outflow this financial year to £322.3bn. This is a significant swing from the cumulative net cash inflow of £10.9bn reported for the equivalent eleven-month period in 2019-20.

The combination of receipts down 5%, expenditure up 27% and net investment up 21% has resulted in a deficit for the eleven months to February 2021 that is around five times as much as the budgeted deficit of £55bn for the whole of the 2020-21 financial year set in the Spring Budget in March, despite interest charges being lower by 27%.

Alison Ring, ICAEW Public Sector Director said: “Today’s numbers are in line with expectations, with the deficit for the past 11 months reaching £278.8bn. This means we are on track for public sector net borrowing to exceed £300bn for the full year once a potential £27bn in bad debts that have not yet been recorded are factored in.

“Our eyes are now focused on what possible tax measures, in addition to the planned corporation tax rise, the government might use to start rebuilding the public finances.”

Table: public sector finances month ended 28 February 2021. Analyses deficit of £19.1bn for month and variances from same month last year.

Click on link at the end of the post to ICAEW article for a readable version of the table.
Table: public sector finances 11 months ended 28 February 2021. Analyses deficit of £278.8bn and change in net debt of £333.03bn and variances from same period last year, together with net debt of £2,131.2bn or 97.5% of GDP.

Click on link at the end of the post to ICAEW article for a readable version of the table.
Table: month by month analysis of receipts, expenditure, interest, net investment and the fiscal deficit for the 11 months to 28 February 2021.
 
Click on link at the end of the post to ICAEW article for a readable version of the table.
Table: month by month analysis of receipts, expenditure, interest, net investment and the fiscal deficit for the prior year.
 
Click on link at the end of the post to ICAEW article for a readable version of the table.

Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.

The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates and changes in methodology. These had the effect of reducing the reported fiscal deficit in the first ten months from £270.6bn to £259.7bn and increasing the reported deficit for 2019-20 from £57.1bn to £57.7bn.

This article was originally published by ICAEW.

ICAEW chart of the week: an unsustainable path

26 February 2021: The Chancellor needs to build a bridge to economic recovery in his first Budget on Wednesday, focusing on jobs, exports and investment. But with the OBR’s official projections showing public debt to be on an unsustainable path, what vision will he set out for the public finances in the long-term?

The Spring Budget announcement on Wednesday will primarily be about the government’s fiscal budget for the financial year commencing 1 April 2021. The UK is still in the midst of a major health emergency and in a difficult economic situation, and the announcement is likely to provide for an extension of support measures for businesses and individuals affected by the pandemic, funding for under-pressure public services and stimulus measures to drive economic growth once restrictions are lifted, particularly in the second half of the financial year. 

In the absence of a formal fiscal strategy event in the Parliamentary calendar, the Budget is also the main forum the Chancellor has to discuss the medium and long-term prospects for the public finances. This includes considering the five-year fiscal forecasts prepared by the Office for Budget Responsibility (OBR), as well as setting out any medium-term fiscal rules the government might want to use in determining its tax and spending plans and in demonstrating financial credibility with debt investors and citizens.

What is often less discussed is the long-term path for the public finances, which – as the #icaewchartoftheweek illustrates – is on an unsustainable path according to the official 50-year fiscal projections prepared by the OBR last July.

These projections indicate that, in the absence of government action, public debt will rise steadily over the next fifty years as public spending grows in line with anticipated demand, and increasing amounts of borrowing will be needed to cover the shortfall between that spending and the amount collected in taxes. It is important to understand that these projections were already on this path before the pandemic arrived and the principal difference between the OBR’s 2020 and 2018 projections is that the initial level of debt has increased from in the order of 80% to just over 100% of GDP. The starting point may be higher, but the fundamental issues haven’t changed.

This financial backdrop permeates every Budget and is the reason the Chancellor finds himself constrained in the choices he can make, despite ultra-low interest rates that currently permit him to borrow huge sums for one-off expenditures at almost no cost. He doesn’t have the same freedom when it comes to permanent increases in spending, whether that be on health, social care, welfare, education, defence or other public services, especially if he wants to minimise the scale of any potential tax increases. Of course, higher economic growth would help – but as successive Chancellors have found that is not so easy to deliver.

So while much of the focus on the Budget on Wednesday will be on the short-term extension of the life support package for individuals and businesses while restrictions remain in place and the economic stimulus thereafter, the Chancellor’s words will also be scrutinised for his vision on the direction of travel for the public finances beyond the end of the next financial year.

This chart was originally published by ICAEW.

IFS: deficit to triple as budget contingency increases

30 March 2020: the Institute for Fiscal Studies (IFS) has suggested that the budgeted fiscal deficit for the financial year starting 1 April 2020 of £55bn could more than triple to £177bn due to the coronavirus pandemic.

In a new publication, the economic research institute also stated that there is a chance the 2020-21 deficit could end up exceeding £200bn.

The Chancellor has already stopped reporting financial estimates for a series of emergency measures, such as the funding of 80% of pay for furloughed workers and support for self-employed workers, incurring tens of billions of public money to keep an economy going whilst in lockdown.

The Contingencies Fund Act 2020 (passed by Parliament on 25 March 2020 alongside the Coronavirus Act 2020), increases the amount available for contingencies from a limit of 2% of spending authorised by Parliament in the preceding financial year to a limit of 50%. In effect, this gives the Chancellor the power to spend an additional £266bn in 2020-21 over and above spending plans already announced, a substantial increase from the £11bn that would have been available otherwise.

The IFS’s estimate assumes that a 5% contraction in the economy would reduce tax revenues by somewhere in the region of £80bn in 2020-21, albeit this would be offset by savings in interest costs following the reduction in the base rate to 0.1% and quantitative easing operations by the Bank of England.

Fiscal measures include the £12bn emergency package announced on the day of the Budget and the £20bn announced on 17 March, together with an estimate by the IFS of £18bn for further measures announced up until 25 March 2020.

The effect on the public finances estimated by the IFS is summarised in the table below.

Estimate of coronavirus revisions to the Spring Budget 2020

Financial year 2020-21Spring Budget
£bn
Economic contraction
£bn
Fiscal measures
£bn

Revised
£bn
Taxes and other income873(80)(22)771
Total managed expenditure(928)8(28)(948)
Fiscal deficit(55)(72)(50)(177)
% of GDP2.4%+3.4%+2.3%8.1%

Source: HM Treasury, Spring Budget 2020; IFS, estimates of economic contraction and fiscal measures to date, 26 March 2020; ICAEW, rough estimate of the split of fiscal measures between waiving tax and additional spending.

The IFS analysis of fiscal measures includes £10bn for the 80% job retention credit for employed workers (for which the IFS have assumed a 10% take-up), but it was prepared for the announcement of support for the self-employed. This could add another £9bn to the deficit for 2020-21.

The IFS has not included the risk of bad debts on the Government’s £330bn programme of financial guarantees and business loans or on the £30bn of second quarter deferred VAT payments. There is also no cost provision for the exposure to additional bank financing and corporate bond purchases by the Bank of England that is being guaranteed by HM Treasury.

Altogether, this would increase the deficit to £177bn, or 8.1% of GDP based on a 5% smaller economy, before taking account of the support package announced for the self-employed. The prospect of further fiscal measures in the weeks and months to come, combined with the risks from loans and guarantees, means that the prospect of a deficit in excess of £200bn is looking increasingly likely.

For more information

  • For the latest news and guidance on the ongoing impact of COVID-19 for businesses and accountants, visit ICAEW’s dedicated Coronavirus Hub.

This article was originally published by ICAEW.

Spring Budget 2020: Hey big spender, spend a little infrastructure with me

12 March 2020: Rishi Sunak’s first Budget as Chancellor of the Exchequer provided a sharp change in direction for the public finances – something that will please and surprise many, according to ICAEW’s Public Sector team.

Spring Budget 2020 combined a short-term fiscal stimulus to fight the coronavirus with higher spending on public services and new infrastructure investment to increase borrowing significantly. Fortunately, ultra-low interest rates will keep financing costs down on the more than £330bn in borrowing planned to finance these plans (not including short-term fiscal stimulus measures), with public sector net debt expected to exceed £2.0tn by 2025.

This Budget is particularly important as it sets the spending envelope for the three-year Spending Review expected to be published later this year. With a higher base for spending following the Spending Round 2019 announced by the previous Chancellor in October, this signals an end to the austerity policies of recent administrations. 

Key headlines for 2020-21:

  • Fiscal deficit up from £40bn to £55bn (2.4% of GDP), before coronavirus measures.
  • No significant tax changes beyond corporation tax remaining at 19%.
  • £14bn extra current spending and £5bn extra investment before coronavirus measures.
  • £12bn in tax and spending measures to respond to the coronavirus.
  • Gross financing requirement of £162bn, including £98bn to cover debt repayments.
  • No reflection of uncertain adverse economic effect of the coronavirus on tax revenues.

Key headlines for the four subsequent years to 2024-25:

  • Fiscal deficit of £62bn (2.5% of GDP) on average over the subsequent four years.
  • Tax policy measures to generate an additional £7bn per year.
  • Extra current spending of £27bn a year and extra investment of £19bn a year.
  • Gross financing requirement of £595bn (£149bn a year) including £315bn to cover repayments.
  • Significant economic uncertainty with coronavirus, global economic conditions and changes in UK trading relationships with the EU and other countries.

The existing plans already incorporated a significant ramp-up in infrastructure and other investment spending with public sector net investment forecast to increase from 2.2% of GDP in 2019-20 to 3.0% by 2022-23. The challenge for the Government will be to deliver and ‘get things done’, especially as capital investment by government departments is expected to increase by 25% in 2020-21 and by a further 35% over the subsequent four years. Will there be sufficient construction capacity and project management expertise to deliver such a rapid expansion and still deliver value for money for taxpayers?

The Budget also contained some important developments in the framework for the public finances, with a specific commitment to review the investment criteria in the Government’s ‘Green Book’ to ensure regions outside London and the South East benefit from the additional infrastructure spend proposed in the Budget. The focus on looking at the effect on investments on the public balance sheet was also welcome with new approaches planned for how to appraise public spending.

One surprise in the Budget announcement was that the OBR did not revise the economic forecasts down as much as had been expected. This was partly because of the economic benefits of higher public spending and investment, but also reflected an improved outlook for productivity. The benefit of this for the Chancellor was that he was able to announce additional current spending on public services, while still remaining within the fiscal rules set out in the Conservative party manifesto.

Unfortunately, the scale of the impact of the coronavirus on the economy is still unclear and so the forecasts for tax revenues may need to be revised downwards, potentially significantly, in the Autumn Budget later this year.

Commenting on Spring Budget 2020, Alison Ring, Director, Public Sector, at ICAEW said: “The Chancellor has announced a major loosening of the taps on spending and investment in his first Budget, with a combination of a short-term fiscal stimulus to fight the coronavirus, higher spending on public services, and a major programme of new infrastructure investment.

Those wondering where all the funding for this planned spending will come from may be surprised to discover that the Chancellor has not followed the custom of post-general election tax rises, but instead has decided to take advantage of ultra-low interest rates to borrow more than £330bn over the next five years. Public sector net debt is expected to exceed £2.0tn by 2025, although the Government hopes that this will then be falling as a ratio to the size of the economy.

Nevertheless, it is a Budget that many will be pleased with, even if a little surprising coming from the traditional champions of small government.”

This article was originally published by ICAEW.