Personal Wealth Management / Politics

UK Budget 2021: Schrödinger’s Tax Hikes

A lesson in politicking and equity markets.

Editors’ Note: MarketMinder Europe is politically agnostic. We favour no politician nor any political party and assess policies’ potential impact on the economy, markets and personal finance only.

Are UK taxes going up or down? When Chancellor of the Exchequer Rishi Sunak unveiled the 2021 Budget Wednesday, he said, “My goal is to reduce taxes. By the end of this Parliament, I want taxes to be going down, not up.”[i] That mission statement capped a speech in which he presented a smattering of targeted tax cuts, including reduced beer and air travel duties; expanded business rates relief for retail; leisure and hospitality businesses; a small reduction in bank taxes; expanded research & development tax credits for corporations; and a reduced taper rate for the universal credit, which gives modest relief to low-income beneficiaries.[ii] He did not announce broad new tax increases—rather, he froze fuel duties and cancelled a previously announced increase on some alcoholic beverages. Yet the Office for Budget Responsibility (OBR), a nonpartisan government watchdog, estimates the UK’s tax burden will hit 33.5% of gross domestic product (GDP, a government-produced measure of economic output) by fiscal 2026 – 2027, the highest since 1951.[iii] (It sees public spending reaching 41.6% of GDP by then, the highest over a sustained period since the late 1970s.[iv]) So … who is right? We would argue the correct answer is both and neither of them, which we also think illustrates why UK stocks have seemingly dealt fine with the prospect of a higher tax burden.[v]

Yes, the ideas in Sunak’s speech technically cut taxes, perhaps scoring some political points—which is what the public Budget spectacle has probably always been about, in our view. But these small measures follow personal and corporation tax increases passed over the summer and a previously announced increase to the National Insurance Contribution. The OBR estimates these increases will add £49.7 billion to the UK’s total annual tax burden by 2026, whilst the cuts announced today total a paltry £1.6 billion.[vi] So, score a fact-check point for the OBR’s bean counters.[vii]

But these are also just projections, and they are based on a number of assumptions. One big assumption: that all of these higher taxes will actually be in place five years from now. We have our doubts, and not just because of Sunak’s pledge to reduce taxes before this Parliament ends. Rather, based on our many, many years of analysing global political developments, we see reason to suspect a lot of this is good old-fashioned politicking. The corporation tax hikes don’t take effect until 2023, which is an eternity in politics, theoretically leaving plenty of room for a rethink. The income tax hikes start next April, but in recent years UK governments have presented supplementary Budgets in March. If they do so again next year, that would give the government an opportunity to change course. They will likely have plenty of motivation to do so, thanks to the presently high inflation rate, which is eating away at households’ disposable incomes.[viii]

The income tax hike, presented in March 2021’s Budget, was something of a stealth rise—it left rates untouched but froze the personal allowance and higher-rate tax band threshold, which normally rise more or less with inflation.[ix] That means as the cost of living and salaries rise over the next few years, many people risk ending up in higher tax bands even though their living standards haven’t changed much. In our experience, this isn’t a good look politically, especially if high inflation is the reason this happens. That could give the government incentive to delay the freeze. And delay it again. And again—scoring political points in the process. Now, this is merely a possibility, but we think it is worth bearing in mind.

Those political points are important because the next general election looks likely to happen sooner rather than later. It is due by May 2024, but a bill to repeal 2011’s Fixed-Term Parliaments Act is wending its way through Westminster—it passed the House of Commons earlier this year and is now progressing through the Lords. If it becomes law, Prime Minister Boris Johnson will no longer need a two-thirds majority to call a snap election—he can merely ask the Queen to use her royal prerogative to dissolve Parliament.[x]

Many political observers we follow think that could happen as soon as next year, potentially giving Johnson and Sunak the opportunity to campaign on big tax cuts. Perhaps adding to their incentives to do so, Labour Party leader Keir Starmer has spoken in favour of cutting taxes, which we think makes tax relief likely to feature in his party’s manifesto. Shadow Chancellor Rachel Reeves echoed Starmer’s messaging in her official response to Sunak’s speech on Wednesday.[xi] Maybe a quick 180 by Johnson and Sunak seems odd, but in our experience, causing problems and then campaigning on solutions to fix them is amongst the oldest political tactics in the book.

As for UK stocks, we think this saga is a lesson in how markets work. Early this year, when Sunak scheduled the corporation tax increase for 2023, he gave businesses time to plan accordingly. In our view, it wasn’t the sort of shock change that would cancel investments overnight. We think that also gave markets time to pre-price it before it started showing up in corporate earnings in 2023, sapping the potential surprise power when (and if!) that eventually happens. Indeed, we think it also flipped the potential surprise power from negative to positive, which likely helps limit the impact on risk-taking. To see this, pretend you are a business owner. If you know the law says the corporation tax rate will rise from 19% to 25% in 2023, you might not like it, but at least you can calculate the rate of return on a new investment and determine whether it is worthwhile. If political uncertainty means there is a chance the tax rate could end up being lower than that, then that is mathematically a bonus, probably not a reason to delay investment.

So overall, we view today’s announcements as politics as usual, and we don’t think it fundamentally changes the outlook for UK stocks. For all the splashy headlines, the changes appear to be only marginal. In our view, global sector and style trends are the main influence on UK returns—meaning, the industry a company is in and whether its earnings are influenced more by long-term technological trends or near-term economic growth rates is likely more important to returns than the country in which it is domiciled. We don’t think political developments are likely to change this in the foreseeable future.

[i] Autumn Budget and Spending Review 2021 Speech as Delivered by Chancellor Rishi Sunak. Transcript accessed at Gov.UK.

[ii] The “taper rate” refers to the percentage of benefits universal credit recipients lose if their monthly income exceeds the £515 threshold. More information is available at: “Universal Credit: What Is the Taper Rate?” Staff, BBC News, 27/10/2021.

[iii] “Economic and Fiscal Outlook,” Office for Budget Responsibility, October 2021.

[iv] Ibid.

[v] Source: FactSet, as of 27/10/2021. Statement based on MSCI UK Investible Market Index returns with net dividends.

[vi] See Note iii.

[vii] A term of endearment, we promise—we like both beans and nonpartisan watchdogs.

[viii] See Note v. Statement based on UK Consumer Price Index inflation rate, which is a measure of price increases across the broad economy.

[ix] “Budget 2021 Sets Path for Recovery,” HM Treasury, 3/3/2021.

[x] “Dissolution and Calling of Parliament Bill 2021-22,” UK Parliament, as of 27/10/2021.

[xi] “Budget 2021: Labour’s Rachel Reeves Responds to Chancellor,” Staff, BBC News, 27/10/2021.

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