Rishi’s £400 billion problem: Where will the axe fall as Sunak prepares 3 March Budget?

Tom Selby
10 February 2021

•    Rishi Sunak’s second Budget as Chancellor of the Exchequer will be delivered against the backdrop of the largest fiscal deficit since World War II
•    Government borrowing is expected to be more than £400 billion higher in 2020/21 than pre-pandemic expectations
•    Sunak and Prime Minister Boris Johnson have reportedly agreed to maintain the Conservative’s ‘triple tax lock’ manifesto promise, meaning there will likely be no increase in income tax, National Insurance (NI) or VAT
•    Pension tax relief, Capital Gains Tax (CGT) and the state pension triple-lock could all be in the firing line come 3 March

Tom Selby, senior analyst at AJ Bell, comments: 

“With an agreement reportedly reached between Number 10 and the Treasury not to increase income tax, National Insurance or VAT rates in the forthcoming Budget, Chancellor Rishi Sunak must navigate a £400 billion high-wire act with one arm firmly tied behind his back.

“To one side he can see the fiery pit of economic disaster if the UK doesn’t get its financial house in order, while on the other is the molten lava of electoral disaster if he cuts too hard, too fast or in the wrong places. With such dangers below, the last thing Sunak wants to do is have a wobble.

“The decision to stick to the triple tax lock manifesto promise has likely been driven by both economic and political pragmatism. 

“As the vaccine rollout gathers pace, there is genuine hope that society will be able to return to something resembling normal in 2021. Increasing income tax or National Insurance just as society opens up would risk strangling any economic recovery we might see and angering voters in the process.

“While Sunak’s options on 3 March are clearly limited, there are alternative revenue raising options open to the Treasury – but even these come with health warnings attached.”

Wealth tax

Policy option: Introduce a wealth tax on all assets above £500,000 per individual

•    Would enable the Chancellor to raise significant funds quickly - a 5% tax on net assets above £500,000 per individual could raise £260 billion according to the Wealth Tax Commission
•    A £500,000 threshold would only impact 17% of the population and could be positioned as only targeting the wealthy

•    Logistically difficult for people to pay on illiquid assets such as their home
•    Could slow down economic recovery

“Rishi Sunak is widely reported to have rejected the idea of a wealth tax and it’s easy to see why. The Wealth Tax Commission proposed that a wealth tax should cover all assets including people’s homes. This would be politically toxic as it would hit older property owners the hardest, many of whom are core Conservative voters and would be unlikely to forgive the Chancellor. Many of these people will have a significant proportion of their wealth tied up in their home and won’t necessarily have the cash available to be able to pay the tax so it becomes logistically difficult to implement.  

“There is also the wider issue of a wealth tax actually hindering the UK’s economic recovery.  Many people have saved money during the pandemic because they are unable to go out and spend it on the things they normally would. That pent-up demand could lead to a sharp economic recovery when lockdown restrictions are lifted and levying a tax on those savings could stifle spending and slow the recovery down.

“Having said that, the figures in the Wealth Tax Commission report will look very appealing to the Chancellor and desperate times sometimes call for desperate measures so a wealth tax can not be ruled out completely, especially if the Chancellor excluded people’s homes and could convince the public that it really is a one off measure to get the country back on its feet.” 

Radical pension tax relief reform

Policy option: Scrap higher-rate pension tax relief in favour of a ‘flat rate’ for all

•    Potential cost saving for the Chancellor, depending on how it is structured
•    Could be framed as redistributing retirement saving incentives but only if the ‘flat rate’ is higher than the current basic rate 20% 
•    May boost the economy in the short-term if it encourages spending over saving

•    Unclear how policy could be applied to defined benefit (DB) schemes and that is where the majority of cost savings for the Exchequer would be realised
•    Would disproportionately impact public sector workers – including doctors, senior nurses and other front line NHS workers
•    Younger savers would miss the opportunity their parents had to benefit from higher-rate tax relief
•    Risks undermining wider efforts to encourage more people to save for retirement and exacerbating UK’s savings crisis

“Speculation the Treasury is planning radical reforms to pension tax relief has become something of a pre-Budget tradition. This has particularly been the case since the Treasury scoped out a range of reform options – including taxing pensions in a similar way to ISAs and introducing a flat-rate of pension tax relief – in 2015.

“The lure of a pensions tax raid to any Chancellor is fairly obvious. Incentivising people to save for retirement via tax and National Insurance relief costs the Exchequer around £40 billion a year – a juicy sum at any time, but particularly inviting with the Budget deficit for 2020/21 expected to top £400 billion.

“However, scrapping higher-rate pension tax relief – the reform which would likely save the largest amount of cash – would neither be easy nor necessarily desirable. 

“The vast majority of tax relief is spent on defined benefit (DB) members, most of whom now reside in the public sector. 

“Even if the complexities of such a move could be resolved, the Government would risk entering a war with the very doctors and frontline NHS staff who have risked their lives caring for patients during this pandemic.”

Less radical pension tax relief reform

Policy option: Reduce the pension annual allowance (currently £40,000)

•    Maintains a strong incentive to save for retirement
•    Relatively straightforward to implement
•    The vast majority of pension savers unaffected

•    Risks hitting public sector workers who are more likely to breach annual allowance through generous DB accrual
•    Further tinkering with the rules risks undermining confidence
•    Unclear how much it would raise for the Exchequer

“A simpler way to raise tax revenue from the £40 billion pensions pot might be to tweak the existing annual allowance, which currently stands at £40,000.

“If this were reduced to, say £30,000 or even £20,000 – in line with the current ISA allowance – the Chancellor could save some cash while leaving the retirement savings options of the majority unaffected. 

“However, such a move would also risk sending an anti-savings message and add to the litany of annual and lifetime allowance cuts we have seen in the past decade or so. 

“This constantly moving feast does not instil people with confidence in the stability of the UK’s retirement rules and undoubtedly puts people off saving for their future.

“Over the longer-term we need to work towards greater stability and simplicity in the pension tax framework. It is crazy that savers potentially have to navigate three different versions of the annual allowance as well as the lifetime allowance when saving for retirement.

“Getting rid of the annual allowance taper and the poorly understood money purchase annual allowance (MPAA) – possibly as a quid pro quo for a lower annual limit - would make understanding pensions a whole lot easier for millions of people saving for retirement.”

Abolish the state pension triple-lock

Policy option: Replace the state pension triple-lock with a lock to average earnings or inflation (or both)

•    Could raise revenue while continuing to protect pensioner incomes

•    Breaks Conservative manifesto commitment
•    Lower state pension for future generations

“While the Chancellor and PM may have agreed to stick by their triple tax lock pledge, there are no such guarantees yet over the state pension triple-lock.

“The policy, introduced 10 years ago, guarantees the state pension increases in line with the highest of average earnings, inflation or 2.5%. For 2021/22 that means a 2.5% increase in the flat-rate state pension from £175.20 a week to £179.60 a week.

“This promise comes at a price, however, with the OBR estimating maintaining the triple-lock would cost £6 billion more than a straight CPI inflation lock and £3.2 billion more than a lock to average earnings.

“Abandoning or watering down this manifesto pledge would undoubtedly be unpopular – particularly among older voters – although given the circumstances it could probably be justified.”

Align CGT with income tax rates

Policy option: Align CGT rates with income tax bands:

•    20% - basic-rate taxpayers (currently 10% or 18% for property transactions) 
•    40% - higher-rate taxpayers (currently 20% or 28% for property transactions) 
•    45% - additional-rate taxpayers (currently 20% or 28% for property transactions)

•    Simplifies the tax system

•    Impact on Treasury revenue uncertain as some may choose not to dispose of assets
•    Could slow down the property market

“After the Office of Tax Simplification (OTS) backed calls to align CGT and income tax rates, the Chancellor could decide to press ahead with the move on 3rd March.

“Doing so would have significant implications for anyone selling assets outside of tax wrappers like ISAs or pensions, as well as those looking to sell a property that isn’t their main residence or business assets.

“At the moment CGT is charged on gains above £12,300 at 10% for basic-rate taxpayers and 20% for higher and additional-rate taxpayers. For properties, the rates are 18% and 28%.

“Aligning these rates with income tax would mean a doubling of the non-property CGT rate for basic and higher-rate taxpayers to 20% and 40%, respectively. Additional-rate taxpayers, meanwhile, would face a CGT rate of 45%. 

“Anyone worried about this who has assets held outside tax wrappers should consider transferring them into an ISA or SIPP, where gains are not subject to CGT.”

Freeze income tax bands

Policy option: Maintain income tax bands at £12,500 (0%), £12,501 - £50,000 (20%), £50,001 - £150,000 (40%), £150,001+ (45%)

•    May go relatively unnoticed

•    Impact on Treasury revenue could be hindered by high unemployment figures
•    Those who face higher tax bills could react by spending less

“Perhaps the easiest way for any Government to raise revenue is by stealth – namely by not increasing the point at which higher tax rates kick in.

“Given millions of people are already facing income uncertainty and unemployment figures are expected to get worse in 2021, the impact of this move on the public finances could be limited. 

“Nonetheless, given the circumstances, it would also be relatively uncontroversial and could at least help rake in a little extra tax revenue.” 

And perhaps a couple of morsels to help struggling savers…

Policy options: Keep the Lifetime ISA (LISA) exit penalty at 20% for 2021/22 and increase the money purchase annual allowance (MPAA) to £10,000

•    Reduces punishments handed out to savers making financial decisions during the pandemic
•    Raising the MPAA will mean people have better chance of rebuilding their retirement pot post-COVID

•    Both measures would cost the Exchequer a relatively small amount of money

“Although the fiscal backdrop to this Budget means the focus will inevitably on revenue-raising measures, the Chancellor might also want to show he’s on the side of hard-working savers too.

“There are two obvious ways he could do this. First, confirm the cut in the Lifetime ISA (LISA) exit charge from 25% to 20% will continue for 2021/22 – or better yet make it permanent. 

“A 20% exit charge simply aims to return the upfront Government bonus, which is fair enough. A 25% charge, however, penalises people at a time when many are facing severe financial hardship.

“Those who take taxable income from their retirement pot for the first time during the pandemic also face having their ability to save in the future severely hampered by the money purchase annual allowance (MPAA). 

“The MPAA reduces someone’s maximum available annual allowance from £40,000 to just £4,000, while also removing the ability to ‘carrying forward’ up to three years’ unused allowances from the three previous tax years. 

“This punishment felt harsh before Coronavirus hit, but in a world where struggling savers might be forced to used their pension assets to make ends meet or help relatives it is difficult to justify. 

“Increasing the MPAA to £10,000 – the level it was introduced at in 2015 – would at least give savers a bit of extra wiggle room to rebuild their retirement funds as the economy hopefully begins to recover post-lockdown.”

Tom Selby
Senior Analyst

Tom Selby is a multi-award-winning former financial journalist, specialising in pensions and retirement issues. He spent almost six years at a leading adviser trade magazine, initially as Pensions Reporter before becoming Head of News in 2014. Tom joined AJ Bell as Senior Analyst in April 2016. He has a degree in Economics from Newcastle University.

Contact details

Mobile: 07702 858 234
Email: tom.selby@ajbell.co.uk

Follow us: