The UK’s Budget Hot-Air Ballooning

The August Bank Holiday is finished, autumn clothing lines have hit the shops, and Parliament is back in session. Must be September! And what an opening it was, with new Prime Minister Andy Burnham facing his colleagues for the first time Tuesday. Taxes were a big talking point during his statement and MPs’ questions, fuelling headlines in several outlets we follow warning he refused to rule out raising them. Add in fresh Treasury leaks about potential energy and bank windfall profit taxes, and we think it is fair to say tax uncertainty is ramping up ahead of late October’s Budget. If recent experience is a guide, we reckon there will likely be more chatter ahead, along with warnings about the allegedly terrible stock market implications. Potential bond market implications likely receive plenty of coverage, too, especially with the conversation starting to shift to potential public spending cuts. These twists and turns can move quickly, being hard to follow. Yet we think there is a silver lining for stocks: All the noise seemingly helps reduce surprise power, likely limiting the Budget’s market implications.

We don’t mean to downplay high taxes. Few like them in our experience, us included. In general, a higher household tax bill leaves less for essentials and fun. A higher corporate tax bill leaves less for workers and shareholders. And in any country on earth, we find there will always be questions about how tax revenue is spent and whether it is optimal. Additionally, in our opinion, a reasonable rule of thumb is that the more you tax something, the less you get of it, which we find can be a drag when higher taxes come for spending, wages, investment and profitability.

But our research finds markets don’t deal in optimal. Nor do we think they rise and fall based on whether a given policy is pleasant. We think they live in the messy reality of real life, which is all about tradeoffs, getting on with things under less-than-ideal conditions and whether things are as bad as, better or worse than expected. So even though no-one we know likes paying high taxes, our research finds stocks have a long history of rising frequently despite them.^[i] Sometimes we think this happens because tax hikes aren’t as bad as investors feared. Sometimes we find it is because they were so widely anticipated that they lost their shock factor. And sometimes we think everything else in the economy was strong enough that higher taxes didn’t cause a noticeable negative effect.

So for UK stocks, we reckon it is sneakily positive that potential tax hikes are in the spotlight now, nearly two months before new Chancellor of the Exchequer John Healey unveils the Budget on 28 October. Abundant tax hike chatter may stir uncertainty and weigh on investor sentiment in the near term, but we think it helps markets price in the potential hikes before Budget Day. The more rumours swirl, the more we find the actual announcement flips from a big risky surprise to a relieving burst of clarity.

We observed this happening with the past two Budgets under former Chancellor Rachel Reeves. Throughout summer 2024, we saw constant rumours that she might raise capital gains tax rates to match income tax rates, which would be a severe hike. So when rates rose only a few percentage points, staying well below income tax bands, we found the Budget spurred some relief amongst investors.^[ii] Last year, meanwhile, we saw ample discussion (and warnings of trouble) about potential wealth taxes, an exit tax on wealthy emigrants and another capital gains increase. Yet these proved false, with the Budget instead including smaller hikes on dividends, high-value property and savings income.^[iii] Compared to earlier warnings, we think it qualified as a relative relief. The upshot: Both Budgets raised taxes somewhat, but neither sank UK stocks.^[iv] The hikes, though painful for those forced to pay up, were much milder than many commentators we follow warned of.

Already, we think this year has the potential to repeat the feat. Since Burnham’s Labour Party leadership campaign, we have seen a raft of tax rumours throughout the financial news outlets we monitor—some from Labour-affiliated thinktanks, some from Burnham’s unnamed allies, some from unnamed Treasury sources to various reporters. Wealth tax chatter has reigned since Burnham stated his opinion that Britain overtaxes work and undertaxes wealth and property.^[v] In late July, government sources briefed journalists that a flat 10% inheritance tax was in the offing.^[vi] A land tax also got some ink then, aimed at addressing the gap in council tax between London and comparably valued properties outside the capitol.^[vii]

Elsewhere, we have seen rumours about a new Social Care levy, similar to the surcharge for National Insurance Contributions (NIC), on workers age 34 and up.^[viii] Midsummer also brought chatter about a higher bank levy, which currently dings banks for 0.05% – 0.10% of liabilities, depending on maturity (in addition to banks’ 8% corporate tax surcharge).^[ix] As vacations started wrapping up later in the month, we saw ample talk of stealth taxes on law firms, charging NIC on wealthy individuals’ state pension payments and lifting the top capital gains rate to 28%. This weekend’s bank and energy windfall profits tax trial balloons were the icing on the cake.^[x] The former would presumably be modelled after the extant energy windfall profits tax, perhaps tied to interest rates (and on top of the aforementioned balance sheet tax and corporate profits surcharge). The latter would purportedly increase and extend the current tax beyond its scheduled March 2030 sunset.

Look, we aren’t saying we think any of this is economically positive. Energy firms have often blamed the windfall profits tax for declining North Sea investment and their lack of interest in exploring further in the UK. Banks’ industry groups generally say they are taxed enough, thankyouverymuch, and that more charges could harm lending.

But we daresay this pushback might be the point. That flat 10% inheritance tax we mentioned earlier? Burnham’s people said it was off the table the very next day after severe public backlash.^[xi] Burnham has also reportedly retreated from plans to nationalise the troubled, scandal-plagued Thames Water utility after the Treasury showed how much it would cost.^[xii] Under Reeves, we saw repeated leaks from His Majesty’s Treasury that certain things were under consideration, with follow-up coverage saying they were off the table after headlines and markets weighed in. Leaks like this strike us as a way to take the public’s and markets’ temperature, and they let policymakers recalibrate if that temperature isn’t good.

We think this is how policy gets watered down, often seemingly bringing relief on Budget Day. From our vantage point, it looks like sentiment gets hung up on the initial proposals and all the analysis showing how terrible they will be for the economy and markets. When those sweeping changes don’t happen, milder change generally ends up being a relief—bullish, in our view. And where bigger changes do go through, they will have generally lost their punch from an investor sentiment standpoint. People will have already reckoned with them. And we find knowing precisely how taxes will change lets people shift from worrying to planning, including planning workarounds. We think all of this can contribute to stocks moving onward and upward as clarity arrives.

In a perfect world, or at least as we would define perfect (such things are always opinion!) Budgets would be boring. We find the annual uncertainty dance affects sentiment, which can affect businesses’ willingness to take risk. That became apparent to us in declining business investment before last year’s Budget.^[xiii] But again, we find markets don’t care whether anything is ideal. Better than expected is the lifeblood of bull markets, in our opinion, and we think the UK probably has plenty of it ahead.