Editors’ Note: MarketMinder Europe is politically agnostic, favouring no party nor any politician. We assess developments for their potential economic and market impact only.
15 March, as Shakespeare wrote in his play Julius Caesar, is traditionally a day for political betrayal and misfortune … so we found it interesting UK Chancellor of the Exchequer Jeremy Hunt chose the ides of March to release his Spring Budget, given the opposition we have seen to some of his plans within his Conservative Party. At any rate, we think the UK’s twice-a-year tinkering with spending and tax rates goes a long way toward showing why stocks benefit from political gridlock. In our experience, inactive legislatures tend to keep fiscal policy relatively static, making it easier for businesses to calculate return on investment. In the UK, our analysis found fiscal policy more of a moving target which we think helps explain why, regardless of whether business taxes rise or fall, investment growth’s long-term trend doesn’t change much.[i] Commentators we follow often deride what they call low-investment Britain, but on the bright side, our study of history suggests the latest tax hikes aren’t likely to be some massive negative for stocks.
The Spring Budget, according to most publications’ coverage we read, was a damp squib. No major tax hike reversals.[ii] Household energy subsidies will now drop in July instead of April, in hopes of wholesale electricity costs falling below the subsidy ceiling by then.[iii] Income tax bands won’t rise—leaving people with higher bills as wage growth lags inflation (broadly rising prices across the economy)—but the government claims new spending on childcare and other social initiatives will leave many households better off.[iv] That program, along with pension changes, aims to get more people in the labour force, on the (in our view, flawed) theory that this will raise economic growth. Meanwhile, the corporation tax rate will rise from 19% to 25% next month as scheduled, but it will come with new investment deductions and other incentives.[v] Some publications we follow have pointed out that, all together, the tax burden will soon be the highest since World War II.[vi] Yet Hunt claims this is “the most pro-business, pro-enterprise regime anywhere.”[vii]
To us, it is a typical fiscal policy package. It appears to include giveaways for some and penalties for others. Rhetorical gymnastics and posturing, in our view. Likely careful deliberation of what to include now, knowing the next election isn’t until January 2025 and policymakers will likely want to save the best for the most politically opportune moment. All just business as usual, in our view. In sum, we think it is probably more political fodder than economic driver.
At the same time, we have seen businesses express frustration, leading to much talk amongst commentators we follow of the corporation tax changes making it harder for the UK to avoid recession this year.[viii] After all, in our experience, the more you tax something, the less you tend to get of it—in this case, profits, which are the fruit of investment. Hence, we have read observers argue the higher rates will discourage investment, dooming the country to slow growth indefinitely.
Hunt seemed prepared for this criticism, which we suspect is why the Spring Budget included a raft of new investment incentives. Presuming it passes Parliament as written, for the next three years businesses will be able to write off every pound of investment against their tax bill.[ix] “Research-intensive” businesses will also get an “enhanced credit” of £27 for every £100 invested.[x] Lastly, the Budget creates 12 new “investment zones” where businesses can compete for grants and subsidies to build new research hubs and other facilities centred around universities.[xi]
So, will it work? Will businesses rate the tax deductions and other sweeteners higher than the tax rate? We think that is impossible to know, though companies’ handling of last year’s Energy windfall profits tax might provide some clues. Officials claimed it wouldn’t discourage oil drilling—leading to shortages and even higher prices later—because they allowed companies to write off 91 pennies of every £1 invested in new oil and gas drilling, which is almost as generous as the investment allowance offered today.[xii] But several major drillers cut their UK investments anyway.[xiii] It seems to us the prospect of sudden tax changes impacted businesses’ investment decisions.
Our research shows the oil and gas industry has its own unique drivers, though. New wells have high up-front costs, and their eventual revenues are hard to predict since prices fluctuate on the market.[xiv] The windfall tax is therefore an important part of companies’ calculations, but we doubt it is the only variable. So perhaps companies outside Energy will find the new system more favourable. Maybe they will see that at 25%, the corporation tax rate will still be lower than at any point before David Cameron’s coalition government started cutting it from 28% in 2010.[xv] Maybe all those new deductions and investment zones will actually incentivise investment. But prior efforts to boost business spending with “super deductions” and “levelling up” plans for Northern England didn’t really bear fruit, making it hard for us to see why this time would be different.[xvi]
That is the thing about business investment, in our view. Despite the tax rate cuts and deduction monkeying of the last decade-plus, it didn’t surge.[xvii] Post-2010 trends didn’t look much different than pre-2010 trends, perhaps because businesses know that what governments giveth, governments can taketh away. We suspect businesses have long presumed they were just one change in government away from higher rates. Exhibit 1 illustrates this, showing quarterly business investment growth and corporation tax rates since 1997, when the investment data begin.
Exhibit 1: Corporation Tax Rates Didn’t Much Influence Investment
Source: FactSet and HMRC, as of 15/3/2023. Investment y-axis truncated for visibility so that one-time events wouldn’t skew the picture.
The other changes making headlines we saw regarding the Budget surround pensions. As the country returned to work following COVID lockdowns, there was a notable drop in labour force participation amongst the over-50 set.[xviii] Many had the financial flexibility to retire early, and the pension system’s lifetime allowance all but encouraged it via stripping most of the tax benefits once a pension pot reached £1,073,000.[xix] Once a defined-contribution plan reached that value through saving and investment, funds above that amount would get taxed at either 55% or the saver’s income tax rate plus 25 percentage points, depending on whether it was taken as a lump sum or via gradual distributions.[xx] Many commentators we follow have argued this discouraged highly paid workers from working until retirement age, pulling doctors and other individuals out of the labour force.
So, in hopes of reversing this and encouraging savings, Hunt announced the government will abolish the lifetime allowance cap and raise annual tax-deferred contribution limits from £40,000 to £60,000, encouraging work and saving in one go.[xxi] Whilst that is possible, we think that, much like the corporation tax world, this change is but a partial offset to individuals’ increasingly high tax burdens. With tax bands not indexed to inflation and personal allowance phasing out as incomes rise, the effective marginal rate on incomes between £100,000 and £125,000 is 60%.[xxii] Will pension sweeteners be enough to offset this and draw people back to work? Only time will tell, in our view, but either way, remember, hiring follows economic growth, not the other way around, according to our research.
Overall, we think this Budget—like all fiscal policy changes—creates winners and losers. Our hunch is that they mostly average out, as, in our experience, is typical with packages like this. Mostly, we think the sheer complexity and ever-changing nature of the UK’s tax system is probably a headwind. To navigate and keep up with it costs significant resources—resources that we can see a case for being deployed more productively elsewhere. Yet this is a status quo that the UK economy and stocks have learned to live with, so we doubt another round is a material negative, especially when there were no big, sudden surprises. The corporation tax hike has been scheduled for nearly two years now, making it very unlikely stocks have yet to price it in. If they aren’t hung up on it, we don’t think investors benefit from being so, either.
[i] Source: FactSet, as of 16/3/2023. Statement based on UK business investment, quarterly change, Q2 1997 – Q3 2022.
[ii] “Spring Budget 2023 Speech,” Jeremy Hunt, HM Treasury, 15/3/2023.
[vi] “Hunt’s Budget Shows Britain Is Doing Less Badly – That’s Not the Same as Doing Well,” Larry Elliott, The Guardian, 15/3/2023.
[vii] See note ii.
[viii] “UK Budget Winners and Losers: The Pound, Gilts and Stocks,” Lucy Raitano and Samuel Indyk, Reuters, 15/3/2023. Accessed via MSN.
[ix] See note ii.
[xii] “What Is the Windfall Tax on Oil and Gas Companies,” Staff, BBC News, 16/2/2023.
[xiii] “UK Oil and Gas Sector Warns Windfall Taxes Are Deterring Investment,” Gill Plimmer, Financial Times, 26/2/2023. Accessed via The Marcet.
[xiv] “Biden Is Blamed for Downturn in New Oil Drilling, but Fossil Fuel Companies Are the Ones Hitting Pause,” Ella Nilsen, CNN, 9/10/2022.
[xv] Source: HMRC, as of 15/3/2023.
[xvi] “North of England ‘Would Rank Second Worst for Investment’ if OECD Country,” Mark Brown, The Guardian, 24/1/2023.
[xvii] Source: FactSet, as of 16/3/2023. Statement based on UK business investment, quarterly change, Q4 2010 – Q4 2020.
[xviii] “Reasons for Workers Aged Over 50 Years Leaving Employment Since the Start of the Coronavirus Pandemic,” Office for National Statistics, 14/3/2022.
[xix] “Pensions Schemes Rates,” United Kingdom Government, 6/4/2022.
[xxi] See note ii.
[xxii] “This Was Underwhelming Stuff – and Could Be Wholly Irrelevant,” Jeremy Warner, The Telegraph, 3/15/2023. Accessed via MSN.com.
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