October 2021 Budget: ambitions for growth

Here’s our take on the October 2021 budget and spending review(1).

Not even a penny off?

Amid enormous detail on a wide range of spending initiatives, and careful positioning of cuts in obscure duties on shipping and sparkling wine, Rishi Sunak may have given the first budget speech in two centuries that didn’t mention Income Tax. The reason of course is that rates and reliefs were frozen in March for several years to come. This will raise a great deal of extra revenue, given the inflationary environment we face. This ‘real terms’ tax rise will arise as more people hit the now frozen Lifetime Allowance limit on their pensions, see no uplift in ISA subscriptions, see no increase in the IHT threshold (none since 2009), exceed the threshold for higher rate tax, and low earners receive pay rises which takes them above the personal allowance. Additionally, the 1.25% Health and Social Care levy, announced in September, is another material rise in ‘tax’ for everyone in work from next April.

Historic levels

In their subsequent briefing, the Office for Budget Responsibility (OBR) made several historical comparisons. The Chancellor has raised more in tax in this budget than any predecessor since the two Chancellors handling the Black Wednesday post-ERM crisis of 1993 – Norman Lamont and Ken Clarke. The State’s share of economy in their forecasts will be at its greatest level since the 1970s, before the Thatcher reforms, and overall tax will be at its highest share of GDP since the Atlee Government in 1948. The short OBR briefing is highly informative and can be viewed here.  

Expanding the State

Rishi Sunak is spending his extra money on several of the Prime Minister’s key policy areas. With 1 in 5 of the population over 70, there’s consistent pressure for more resources for the elderly. Extra money is required to ‘level up’ society, develop the regions, add transport links and improve education. A ‘net zero by 2050’ agenda will be capital intensive and disruptive. Support for consumers with rising energy prices, the living wage increased to £9.50 per hour, and subsidising rail (with fewer fare paying passengers) are expensive interventions. Click here for the full details on the spending review.

Economy recovered well, new fiscal tests

The expected damage to the economy from the pandemic has not been as bad as feared. The ‘scarring effect’ on long-term growth is expected to be 2%, only half the impact of Brexit, which will reduce GDP by 4%, having caused a 10% decline in our trade with Europe. In the context of the huge spending needed to sustain the economy in lockdown, Rishi Sunak has announced a set of 4 additional fiscal tests to express his commitment to keeping the public finances under tight control. Implicitly, he is teeing up the possibility of a tax cut later in this Parliament. He’s aiming to reassure the Government’s supporters he doesn’t intend to spend yet more of their money.

Ambitions for growth

The hard facts of his situation and a lack of margin for error, are all too obvious to the Chancellor. His focus is very much on actions to create an environment where a stronger, better skilled economy can emerge. One example that will resonate in financial advice is his £560m ‘Multiply’ plan to help hundreds of thousands of adults with numeracy skills. Will it be enough? In parallel are headline grabbling plans for additional R&D, urban regeneration and infrastructure improvement, particularly with broadband. A quicker growing economy should give him more room for manoeuvre and the cash to cut taxes.

Inflation, the wild card

Chart showing CPI Inflation between 2020 and 2021

Restructuring the Government’s debt away from fixed towards floating rates means that any 1% rise in inflation and interest rates adds £23bn a year to Government spending, a sum comparable to the £30bn headroom the Chancellor has spare to meet his new fiscal tests within this Parliament. It’s going to be tight.  He accepts we’ll be seeing 4.4% inflation next year. At the moment there’s only localised pressure on wages in the economy, most obviously among HGV drivers, but a wage/inflation spiral would spoil all his numbers and fail him on his own tests for fiscal prudence. The OBR did point out that no Chancellor has yet met their own tests in this area. And we won’t know how accepting the public sector will be towards its first pay rise in two years until those settlements are announced in Spring. We should all be hoping that global supply chain bottlenecks unravel quickly and that recent energy price spikes, a by-product of the global growth rebound, are temporary. And of course, hoping for a winter in which the NHS manages to cope within the considerable means already committed for our care.

Conversation cues

Those on fixed incomes will need to consider their expenditure budgets to identify how they’ll respond to pressure from inflation on living standards and the lack of inflation linked increases in tax reliefs. Those taking dividend income will face an additional 1.25% tax from April 2022. The dividend allowance will stay at £2,000 and not rise with inflation.

Freezing of reliefs will impact financial planning models where their inflation linking has been assumed.

With Treasury revenue at a premium, an extra £292m has been allocated to HMRC over three years to combat tax evasion.

The Government announced it will take a tougher line on the high income child benefit charge, after its position has been threatened by a legal decision.

Reform of business rates has been deferred but the planned increases from next year have been cancelled. There will be a freeze on the ‘multiplier’ inflation linked element for all, and £1.7bn of relief for hospitality and entertainment businesses via a 50% discount next year. Employers will be paying an extra 1.25% in NIC next year and paying a higher minimum wage to their staff.

The sensitivity of investment valuations to interest rate rises is a key issue given the economic, fiscal and inflationary context.

(1) https://www.gov.uk/government/news/budget-and-spending-review-october-2021-what-you-need-to-know

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