It was never likely to be a particularly show-stopping Budget, not least because little was expected to have changed since the previous Budget announcement last year, and Chancellor George Osborne’s rhetoric seemed to confirm this in the early stages of his speech to the House of Commons. Osborne prepared his audience by stating that this was “not a tax-raising budget but nor can we afford a giveaway” and was to be “a budget for making things not for making things up”. But there was a twist in the tale of the one-hour speech, when Osborne not only announced a Fair Fuel Stabiliser but also a 1p cut in fuel duty with the aim of mitigating the impacts of high inflation.
Though there weren’t any big surprises other than the fuel duty cut, among the more interesting points to emerge from this month’s Budget was the reduction in economic growth forecasts from the Office for Budget Responsibility, the implication that pension age be linked to longevity, and the move to reduce the corporate tax rate but to exclude banks from this development. The overall impact of the proposed changes, however, is “unlikely to raise investment growth until 2013 at the earliest and unlikely to have significant effect on productivity until 2015 and beyond,” in the words of Centre for Economic and Business Research CEO Douglas McWilliams.
The Catch-Up Economy
Osborne said his Budget “confronts the hard truth that’s been lost for too long: Britain’s lost ground and needs to catch up”. He highlighted that the UK’s fiscal plans come strongly endorsed by the IMF, OECD, and the domestic business community and underlined that low interest rates are a powerful tool for boosting economic growth in the wake of the sharpest fall in output since the 1930s and the largest banking crisis in the entire history of Britain. But all this was to soften the blow of what was to come next: news that the OBR is now forecasting annual growth in 2011 of just 1.7%, down from 2.1% previously forecast, due to a weaker-than-expected fourth quarter of 2010, the recent rise in commodity prices, and higher-than-targeted inflation.
Though Osborne’s critics have since been quick to jump on the forecast reduction as a by-product of too severe austerity measures, the downgrade itself was widely expected and the fact that equity markets barely even blinked in response is proof that the announcement was not groundbreaking.
The UK economy is still set to grow in each of the next five years, Osborne pointed out, as he unveiled the OBR’s forecast for real GDP growth to rise to 2.5% in 2012, 2.9% in each of 2013 and 2014, and to then slip a touch to 2.8% in 2015. The UK is on the path to outperforming the economic growth of the eurozone and the European Union this year and in spite of a higher government debt ratio continues to offer lower interest rates than neighbours France and Germany. Such optimistic comments are partly offset by the reminder that inflation is currently 4.4%. But Osborne believes that once the 4%-5% levels expected for the rest of 2011 are behind us, inflation will drop to 2.5% next year and will arrive at the Bank of England’s mid-range target of 2% in two years’ time. Public sector borrowing is also higher than hoped for, seen at £146 billion this year but falling to £29 billion in 2015/2016. The chancellor says he will meet his target that debt should be falling as a percentage of GDP by 2015/2016 and in fact he will meet it one year earlier.
Tax Shouldn’t Be Taxing, It Should be Simple
Big Business: “Taxes should be simple and support growth,” Osborne told his audience. And in an attempt to bolster the private sector’s ability to take the burden of fuelling economic growth from the public sector, the Chancellor unveiled double the cut he’d previously planned for the main corporate tax rate, so that from April big business will see its tax bill lowered by 2% rather than 1%. Corporate tax rate will continue to fall by another 1% in each of next three years, taking it down to 23% by the end of parliament. Such measures should help spread the word that “Britain is open for business” Osborne said.
“The acceleration in the planned reduction in corporate tax rates is helpful to equities and may at the margin underpin an improvement in corporate spending, which is important to sustaining the recovery,” Richard Buxton, Head of UK Equities at Schroders, commented shortly after the announcement.
Lest such a move be criticised as yet another carrot for big banks, the Chancellor swiftly followed up news of the corporate tax reduction with the assurance that he will be adjusting the bank levy next year to offset its effect and ensure it is not a net tax cut for banks. It was this latest announcement that prompted perhaps the greatest cheer of the Budget statement from Osborne’s Right Honourable friends on the benches.
“Increased levies on banks merely add to the plethora of headwinds and uncertainties which the sector faces,” responded Buxton, “but again are of limited impact against the broader issues of working towards regulatory clarity and the restoration of medium-term return on equity targets.” These latter points continue to support the investment case for the banks, Buxton believes, though he reiterated this afternoon that “it was always going to be a multi-year recovery process.”
Small Business: Today’s Budget was clearly big business-friendly, but there were some changes for smaller businesses too. All businesses employing less than 10 people and new start-ups will be exempt from business regulations, the Chancellor has agreed with banks to a 15% increase in the availability of credit to small business, a range of small business tax breaks including lower rates for those based in 21 new ‘enterprise zones’ are on offer, and small business rate relief is to be extended for a year to October 2012.
The Forum of Private Business’ response to such announcements carried an upbeat tone but the organisation labelled the measures “short-term” and argued that more needs to be done in the long term if small businesses are to drive economic growth and job creation. The Forum of Private Business said it welcomed the measures on fuel duty, which “should provide some cash flow relief for struggling small firms”, and also welcomed the small business tax breaks, but it is disappointed that the Chancellor’s reduction in the main rate of corporation tax is not also being applied to the rate paid by small profit business.
Individuals: Following recommendations from the Office for Tax Simplification, today’s Budget abolishes 43 complex tax reliefs and introduces several measures aimed at simplify the British tax regime. Whether it has succeeded in doing so looks set to be a topic of debate for some time to come, however.
The main announcement of note is that of plans to consult on the merging of the income tax and National Insurance systems. Such a task is one that has been high on policy-makers list for years, not least because of the burden it places on employers, HMRC and individuals, but it is one that is likely to involve a very long and arduous process. Osborne was quick to note that the merging of income tax and NI will not mean that the latter is applied to pensioners, for example. “The Government will not extend NICs [National Insurance Contributions] to individuals above State Pension Age or to other forms of income such as pensions, savings and dividends” as stated in the Budget document. The creation of NI this year celebrates its centenary, having been launched in 1911 with the aim of funding pensions and other welfare payments, but the exact purpose and outcome of such a ‘tax’ is less clear cut these days. Osborne’s comment today that it will “involve a huge amount of consultation and take a number of years to complete” underlines the complexity of merging the two systems, as well as the concern that the result could be seen as simply raising income tax.
Other tax reform includes a discount on inheritance tax for the charitable, a widely-expected increase in the personal tax allowance, and indexing direct tax to CPI. Someone who leaves 10% of their estate to charity will receive 10% off their inheritance tax, so that the net benefit is to charities rather than individuals. From April 2012, the personal tax allowance will rise to £8,105. At the other end of the individual’s tax spectrum, Osborne commented that the 50% tax rate for higher earners is a temporary measure but one that he feels cannot yet be removed. The Chancellor has requested that HMRC see how much additional revenue this higher tax raises when self assessment forms come in and he will reassess at a later date. The government will also switch the default indexation assumption for direct taxes to CPI from 2012/2013.
Pensions to Be Linked to CPI and Longevity
Headline-grabbing pension reform was confirmed at the last Budget announcement, so little new was expected this time round. Among the multitude of minor changes, Osborne revealed that, as with direct taxes, public sector pensions will also be index to CPI, though this time starting in the 2011/2012 tax year. This is just one of several adjustments aimed at reducing the public sector borrowing requirement. The state pension system is to be simplified, including a proposal to create a single-tier system that will offer individuals around £140 per week, bringing closer the end of the Defined Benefit scheme and supporting personal responsibility.
Osborne also said he hoped to see a more automatic mechanism for increasing the pension age and will therefore bring forward plans to review this process, potentially encompassing regular independent reviews of longevity changes. With the state pension age set to rise to 66 by April 2020, this implies further increases could perhaps take place faster and/or more frequently than previously proposed.
Relaxing EIS and VCT Investment Rules
In a move that has been applauded by industry participants, the Chancellor also unveiled plans refocus efforts regarding enterprise investment schemes (EISs) and venture capital trusts (VCTs). The former will see tax relief raised to 30% from 20% and both EISs and VCTs will enjoy more lax investment rules.
“The Budget has put VCTs and EIS back where they belong and that’s at the heart of enabling private investors to get behind British innovation and allow more companies – not just start-ups – to benefit from tax-efficient investment,” commented Julian Hickman, Partner at Longbow Capital. “The Chancellor has dealt a very generous hand to British companies involved in creating wealth through innovation. The number of businesses that will be able to benefit from EIS and VCTs will increase dramatically as a result of today’s Budget,” he added.
The total amount that can be invested by a VCT or EIS into an individual company will now be increased to £10 million from £1 million and the maximum that can be invested in an EIS is set to rise to £1 million from £500,000.
Ian Sayers, Director General of the Association of Investment Companies (AIC) was similarly effusive about proposed changes. Noting that the withdrawal of bank finance and challenging market conditions have increased the difficulties facing smaller companies seeking capital, and that VCTs’ ability to channel funds to these businesses has been limited by European rules, Sayers commented: “The Chancellor’s decision to roll back these rules so that VCTs can deliver finance to more companies who need it will be warmly welcomed by the VCT sector and those SMEs which rely on its support.”
Cheaper Fuel in the Tank
“Price of petrol has become a huge burden on families,” Osborne opined as he prepared to launch into his pièce de résistance. Preparing the scene with a reminder that the previous government introduced a new fuel escalator that laid the scene for seven price increases, three of which have already taken place and the fourth being due next week, the Chancellor announced he is not only scrapping the fuel escalator but also cutting fuel duty by 1p in the pound from 6pm this evening.
Osborne is to introduce a fair fuel stabiliser that will mean that from tomorrow the supplementary charge on production of oil from the North Sea will rise from 20% to 32%. It will be this new tax revenue that will be used to delay the rise in fuel inflation, which will be reintroduced if the oil price drops below a certain level, to be consulted on forthwith.
Such a tax will clearly hit producers but Osborne pointed out that the last time the North Sea Oil regime was reformed was back in 2006, when the oil price was around $66 a barrel. At $106 at last check, companies operating in the area are generating substantially more profit from its extraction relative to the relevant tax. Though immediate questions come to mind as to how to prevent such multinational corporations from passing on this tax to the consumer, we are reminded not only that the price of crude is set by the markets rather than the oil companies, but also that it is in the interest of oil producers to keep the end cost low if they are to successfully compete with peers. For the record, shares in UK-listed multinationals Royal Dutch Shell (RDSB) and BP (BP.) were comfortably higher in the hours following the Budget. UK-focused producers, however, were far less resilient: mid-caps Enquest (ENQ) and Premier Oil (PMO), and AIM-listed Nautical Petroleum (NPE), plunged 12%, 5% and 9% in Wednesday afternoon deals.
“The scrapping of the fuel escalator and the introduction of a fair fuel stabiliser is a step in the right direction for improving stability in the medium term,” commented Azad Zangana, European Economist at Schroders. However, “the penny cut in fuel duty as opposed to the five pence rise that had previously been planned should help reduce inflation in the short term,” said Zangana, adding that “This in turn will give the Bank of England a little more time before it has to raise interest rates.”
