The taxes Labour might hike in its first Budget

The announcement that the new government is targeting tax rises less than a month after gaining power is not something we wanted to hear. But it hasn’t come as a huge shock, either.

In a speech to the House of Commons yesterday, Chancellor Rachel Reeves said a Treasury spending audit painted a worrying picture of the UK’s public finances, unearthing a £22 billion “black hole” of unfunded pledges from the previous government.

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This is what she had to say: “Before the election, I said we would face the worst inheritance since the Second World War. Taxes at a 70-year high. Debt through the roof. An economy only just coming out of recession. I knew all those things.

"I was honest about them during the election campaign. And the difficult choices it meant. But upon my arrival at the Treasury three weeks ago, it became clear that there were things I did not know.”

Reeves stressed the gap must be plugged, requiring savings of £5.5 billion and £8.1 billion this year and next, respectively. The chancellor committed to setting out full fiscal plans alongside a spending review, at the new government’s first Budget which will take place on Wednesday 30 October. 

Needless to say, the opposition were quick to slam Reeves’ claim. Shadow Chancellor Jeremy Hunt fired back: “That great office of state depends more than any on trust. In her first big moment, she breaks that trust with an utterly bogus attempt to hoodwink the public about the choices she has.”

So, it seems nailed on that some personal taxes will be shaken up in three months’ time, and not in our favour. But which ones will the government target? Let’s examine the options.

National insurance reversal unlikely to happen

Perhaps the simplest and easiest way to square the Treasury’s coffers would be to reverse the national insurance contribution (NIC) hikes from the last two fiscal events – the 2023 Autumn Statement and this year’s Spring Budget.

Then-chancellor Hunt slashed employee class 1 NICs from 12% to 8%, reduced class 4 NICs from 9% to 6% and scrapped class 2 NICs, to support the self-employed.

In response to Reeves’ speech, Paul Johnson, director at the Institute of Fiscal Studies, tweeted: “Notable that the £20 billion cut in NICs announced by last government is roughly equal to [the] hole that has been identified. That cut looks less and less advisable. But so, surely, is the refusal to reconsider it.”

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As Johnson notes, the Labour government, however, has pretty much taken the option to undo these hikes off the table. In its manifesto, the party pledged not to raise the headline rates of NICs, and extended this promise to income tax, value added tax (VAT) and corporation tax.

The Labour Party doesn’t have to keep this commitment and has the discretion to go back on its word if it feels change is necessary to put the country on a firmer footing. That said, such an abrupt U-turn may make an immediate dent in the new government’s credibility with voters – something Starmer and Reeves will want to avoid.

Wealth taxes are in the government’s sights

The two wealth taxes - inheritance tax (IHT) and capital gains tax (CGT) - were strikingly omitted from Labour’s manifesto. And as such, seem obvious targets for the new chancellor.

The Resolution Foundation’s Wealth Report, published on 28 July, found that “unearned passive wealth” is driving a wealth divide in the UK.

The think tank said: “These gains have stretched the gap between the wealthy ‘haves’ and the less fortunate ‘have nots’: today, families in the top 10th of the wealth distribution have £1.3 million more in wealth per adult on average than those around the middle (fifth decile). Yet, despite huge increases in wealth, revenues raised from wealth-related taxes have barely moved, at around 3% of GDP.”

The report goes further, claiming that reforms to CGT and IHT could collectively raise almost £10 billion a year - an appealing option if the government wants to avoid sharp cuts to some public services and to keep its word to leave headlines taxes on income unchanged.

In an article earlier this month – just before the election – I speculated what shape changes to CGT and IHT could take if Labour won. Given this has since come to pass, it’s worth taking another look to consider what might happen in October, and include any fresh reports.

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With CGT, one bold option is to equalise the system with income tax, which would hike the minimum and top rates for investors from 10% to 20% and 20% to 45%, respectively.

This was a suggestion made by the Office for Tax Simplification (OTS) in November 2020.

Bill Dodwell, tax director at the OTS, said: “If the government considers the simplification priority is to reduce distortions to behaviour, it should consider either more closely aligning capital gains tax rates with income tax rates, or addressing boundary issues as between capital gains tax and income tax.”

The report also recommended the annual exemption should be reduced, which, as many investors will know, the previous government took on board. This tax-free allowance was cut from £12,300 to £3,000 over the space of two years, hurting the gains of investors with holdings outside tax wrappers such as self-invested personal pensions (SIPPs) and individual savings accounts (ISAs).

With regards to IHT, there are reports Labour might scrap reliefs for farms and businesses, which may also deal a blow to investors as qualifying AIM shares are 100% exempt from IHT if held for two years under business relief rules.

Elsewhere, an increase to the current 40% headline rate of IHT has also been reported, but this seems unlikely.

Pensions could be a soft target

One of the main reasons why people choose pensions over other savings vehicles is due to their attractive tax advantages – particularly those upfront and on death. However, Labour may home in on some of these in a bid to balance the books.

According to reports, the Treasury has urged Reeves to usher in a 30% flat rate of upfront tax relief on pension contributions. The current system applies tax relief at your marginal rate – in other words, the rate you pay on your next pound of earnings.

Put simply, if this change was brought in, 20% taxpayers would gain, while anyone in the 40% or 45% tax brackets would lose out.

The government could also water down the pensions tax-free lump sum entitlement. At present, this is usually 25% of your total pension savings, up to a maximum of £268,275.

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A further option is to close off or reduce the tax benefits on inherited pensions. As things stand, if you die before age 75 your loved ones can receive your pension benefits free from IHT, and they pay no income tax on any lump sums or income withdrawals.

If death occurs after 75, there’s still no IHT, but the beneficiary pays income tax at their marginal rate on anything they withdraw. Removing the pre-age 75 tax-free status could raise some extra cash for the government.

To note, any changes to the pension tax system would not prove popular, particularly to those with large incomes or sizeable pots, and may risk deterring some savers from beefing up their pension savings.

What should investors do in advance?

To use a golfing term, you should play the course as you find it. In other words, and to link this to tax planning, switching up your portfolio based on speculation should largely be avoided. It’s better to plan your financial future based on what you know. Labour’s decision to abandon plans to reinstate the pensions lifetime allowance (LTA) – the amount your pension savings could be worth tax free – is a case in point.

Either way, keeping your money away from the taxman will become increasingly important as we move through the current Parliament.

As soon as Reeves has delivered her inaugural Budget speech on 30 October, I’ll round up what’s due to change, and importantly outline anything you can do to protect your wealth.