The UK’s Budget Hot-Air Ballooning

School is back in session and so, with the calendar’s turn to September, is the UK Parliament. As new Prime Minister Andy Burnham faced his colleagues for the first time, taxes were a big talking point, fueling headlines warning he “refused to rule out” raising them. Marry that with some fresh Treasury leaks about potential energy and bank windfall profit taxes, and it is clear tax uncertainty is ramping up ahead of late October’s Budget. Expect more chatter, along with warnings about the allegedly terrible stock market implications. But for stocks, all the noise helps reduce surprise power, limiting the Budget’s market implications.

We don’t mean to downplay high taxes. No one likes them, us included. 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, there will always be questions about how tax revenue is spent and whether it is optimal. It is also generally true that the more you tax something, the less you get of it, which can be a drag when higher taxes come for spending, wages, investment and profitability.

But markets don’t deal in optimal. Nor do they rise and fall based on whether a given policy is pleasant. 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 likes paying high taxes, stocks have a long history of rising despite them. Sometimes it is because tax hikes aren’t as bad as investors feared. Sometimes it is because they were so widely anticipated that they lost their shock factor. And sometimes it is because everything else in the economy was strong enough that higher taxes didn’t cause a noticeable negative effect.

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

This happened with the past two budgets under former Chancellor Rachel Reeves. Throughout summer 2024, hot rumors said she might raise capital gains tax rates to match income tax rates, a severe hike. So when rates rose only a few percentage points, staying well below income tax bands, the Budget spurred some relief. Last year, meanwhile, fears of wealth taxes, an “exit tax” on wealthy emigrants and another capital gains increase proved false, with smaller hikes on dividends, high-value property and savings income proving to be a relative relief. Both Budgets raised taxes somewhat, but neither sank UK stocks. The hikes, while painful for those forced to pony up, were much milder than feared.

Already, this year has the potential to repeat the feat. Since Burnham’s Labour Party leadership campaign, we have seen a raft of tax rumors—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. In late July, government sources briefed journalists that a flat 10% inheritance tax was in the offing. 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.

Elsewhere, we have seen rumors about a new Social Care levy, similar to the surcharge for National Insurance Contributions (NIC), on workers age 34 and up. Early August 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). As vacations started wrapping up later in the month, there was 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. The former would presumably be modeled 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 2023 sunset.

Look, we aren’t saying any of this is good. Energy firms have blamed the windfall profits tax for declining North Sea investment and their lack of interest in exploring further in the UK. Banks 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 DOA the very next day after severe public backlash. Burnham has also retreated from plans to nationalize the troubled, scandal-plagued Thames Water utility after the Treasury showed how much it would cost.^[i] Under Reeves, His Majesty’s Treasury repeatedly leaked that certain things were under consideration, then said they were off the table after headlines and markets weighed in. Leaks like this are a way to take the public’s and markets’ temperature, and they let policymakers recalibrate if that temperature isn’t good.

This is how policy gets watered down, bringing relief on Budget Day. 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 don’t happen, milder change ends up being a relief—bullish. And where feared changes do go through, they will have generally lost their punch. People will have already reckoned with them. And knowing precisely how taxes will change lets people shift from worrying to planning, including planning workarounds. All of this can contribute to stocks moving onward and upward as clarity arrives.

In a perfect world, Budgets would be boring. The annual uncertainty dance affects sentiment, which can affect businesses’ willingness to take risk. That became apparent in declining business investment before last year’s Budget. But again, markets don’t care whether anything is ideal. Better than expected is the lifeblood of bull markets, and the UK probably has plenty of it ahead.