Budget 2015: tax promises leave little room to drive a viable economic plan

The new Conservative government is set to unveil its first post-election budget. In fact, it will be the first by a Conservative government since 1997.

What is the chancellor likely to do? During the election campaign, the government promised that it would not raise income tax rates, national insurance contributions or the VAT sales. So it is safe to assume that there will be no hikes?

A number of changes are expected to meet the election pledges. These include raising the annual income tax personal allowances from the present amount of £10,600 to £12,500 by 2020. This means that the first £12,500 of all earnings will be exempt from income tax. In addition, the government promised to increase the threshold for the 40% marginal rate of income tax from £42,385 to £50,000 by 2020.

Shades of grey

Other pre-election promises included changes to inheritance tax. Currently, the estate of a deceased individual can be liable to inheritance tax of 40% on assets above £325,000. The estate of a couple may enjoy an exemption of £650,000. The government hinted at raising this threshold to £1m. The Conservatives appealed to the grey vote by promising to increase the state pension by £1,000 over the next five years. By 2020, the state pension of a single person is likely to be around £7,000 a year.

Soaking up the attention. Pensioners and politicians.Walt Jabsco, CC BY-NC-ND

The above and other promises are likely to be paid by restrictions on the tax relief on pension contributions enjoyed by the wealthy. These are likely to affect individuals earning more than £150,000 a year. The rich could be appeased by promises to cut the 45% rate of income tax, which currently applies to taxable incomes above £150,000, although this is now looking less likely.

Debt dependent

During the election campaign, the government said that is would raise £5 billion from a clampdown on tax avoidance, but previous initiatives have failed to deliver the promised revenues. The government may well yield to the banking lobby’s demands for an end to the bank levy, which is expected to raise around £3.6 billion a year.

The biggest changes are likely to be cuts to the welfare budget as the government is committed to reducing the public debt from £1.6 trillion. Despite persistent child poverty, the government is looking to cut about £12-13 billion from the welfare budget. Over a period, the scale of cuts is likely to be more severe as the government is committed to generating budget surpluses.

Foundations

What should the government do to build a sustainable economy? The post banking crash economic recovery is still weak and the government is relying on economic growth to generate tax revenues to meet its goals. Economic growth depends on people having sufficient purchasing power. The share of GDP represented by UK workers’ wages has shrunk to about 50.5%, the lowest ever recorded.

The poorest fifth of households pay 37.8% of their income in direct and indirect taxes compared to 34.8% for the richest fifth, but the government will not reduce the rate of VAT, which hits the poorest the hardest.

The government is unlikely to boost the purchasing power of the poorest by forcing employers to pay a living wage. The Living Wage campaign has gained some influence with its calculation of the hourly rate which allows employees to meet a standard cost of living. It sits at about £9.15 an hour in London and £7.85 an hour in the rest of the UK. This compares to a national minimum wage of £6.70 per hour.

The government is also unlikely to borrow money to finance new green and high technology industries to create well-paid skilled jobs.

Lend and spend.Chris Goldberg, CC BY-NC

So how is government seeking to aid economic recovery? It is encouraging citizens to borrow and spend. Artificially low interest rates – although not directly a function of government policy – are encouraging citizens to borrow and consume more. UK household debt is about £1.4 trillion and expected to rise to £2.3 trillion by 2019.

Additional consumption is also being encouraged by the recent pension reforms which enable some retirees to cash in their pension pots. Around £6 billion is expected to be withdrawn by retirees to spend as they please. This will also boost the government’s tax revenues by about £1.2 billion. Of course, there are questions about how household debt is to be repaid and what will happen to pensioners later in the lives when a large lump of their savings has been lavished on holidays, cars and luxuries. Perhaps the government can’t see beyond the next election.

The UK desperately needs a new economic strategy, but Wednesday’s budget is unlikely to announce one.

Disclosure

Prem Sikka is director of the Association for Accountancy & Business Affairs (AABA), a not-for-profit organization registered in the UK.