To tax or not to tax, that is the question?

The noise from clients has been very intense leading up the Budget in a fortnight’s time. The Government has done a great job spinning ideas about different ways they might increase tax. Last week at 8am on a Tuesday morning, Rachel Reeves unconventionally jumped onto our airwaves to fuel the idea of raising income tax rates, and to set the scene to break the promise of the Labour parties manifesto after only 16 months of being in power.

Historically chancellors have remained tight lipped ahead of a budget, so last Tuesday can only be construed as an attempt to prepare the country and wider investment markets that something quite dramatic is required to improve the country’s finances. In fairness, they are probably right, though this morning it was leaked that she may now not follow through on this plan… so who knows where we might be come the 26th.

What are the likely options available to Reeves? A quick look back in history points to lots of ways that chancellors have tried to increase tax revenue. Sometimes they look to raise tax via a number of indirect raids, rather than just going straight for the jugular. Perhaps one of the strangest attempts that springs to mind would be George Osbournes ‘pasty tax’. Back in 2012, the Tory party wanted to add VAT on food sold at what was deemed above an ambient temperature’. For those that don’t know, VAT is not charged on a ‘cold food’, though it is charged on ‘hot food’. Hence the tax was deemed as the pasty tax. A short time later under much public pressure, Cameron reversed the plan claiming that he was rather partial to a meat and potato pie himself!

Alas, I am doubtful that Rachel’s speech last Tuesday was positioned in order for us to prepare ourselves for an extra 25p on a bacon butty, instead it is far more likely that we will see an increase in one of the core taxes (income tax, National Insurance or VAT). The advantage here is that a significant level of capital can be raised from one main source, and it’s much easier to administer. Bond markets (plenty of exposure in our portfolios), were liking the idea of a 2% rise in Income Tax, and had rallied quite significantly in recent weeks in support. Partly, this is because it is much easier to measure the benefit to the UK’s finances and additionally raising income tax is also disinflationary (because people will have less money to spend so demand for goods will likely fall). This would then push the Bank of England to cut interest rates to redress the balance (good for bond markets) and hopefully whatever the Government invests in will help stimulate enough to keep us out of recession! We can then start work on filling in that black hole that has doubled in size in the last 12 months. So whilst on the surface this might sound terrible, markets were telling us they liked the income tax plan (until this morning when they reversed course). Either way, the maths (and the data) suggests there is trouble ahead, and we really do need to start digging.