George Osborne's first Budget as Chancellor of the Exchequer will be on Tuesday 22 June at 3.30pm. Putting aside the sheer excitement of two Budgets within just over 3 months (I'll have to go for a lie down soon) this is of course an extremely important Budget for a number of reasons:
1. Given the colossal scale of the Budget deficit, it will set the tone for the coalition's fiscal and spending policy for the next 5 years.
2. It will be closely examined to see how far it reflects the (to some extent) divergent policies of the coalition partners.
3. It has the potential to nudge the UK economy back into recession if it cuts the wrong things or cuts too deeply, or imposes too much of a tax burden on a struggling business sector.
4. It is a massive first test for an unproven Chancellor, who has at least 3 people on the coalition front bench with him who a number of people believe are better qualified to do his job than he is (I'm thinking of Messrs Hague, Clarke and Cable, unless you have any other candidates).
So let's have a think about these factors, and see where they might lead Mr Osborne on 22 June.
We have already had a fair insight into the coalition's tax plans last week, so were are potentially better informed on that side of the agenda than the spending side. Apparently the government is looking at £6 billion of immediate spending cuts, which will not be in the areas of health or international aid. Nor, we are assured, will they impact on front-line services, which, as an assurance, is about as standard in these circumstances as pre-election claims that there are £billions of bureacratic waste just waiting for a new government to cut. The latter, incidentally, tend to prove frustratingly elusive once the new government gets into power.
I like the story from David Laws, Chief Secretary to the Treasury, that his predecessor Liam Byrne left him a note saying "There's no money left", but joking apart, the main hint we have had on the targets for cuts is a scaling back of child tax credits and child trust funds for those on above average incomes. I also wonder whether the phenomenally generous grant and matched funding regimes for business training will also have an appointment with the scissors, but the spending side of the budget equation is not my specialist subject.
I have been rather surprised by the extent to which the tax proposals released so far are influenced by Liberal Democrat policy; perhaps evidence of hard bargaining by Team Clegg in the coalition negotiations, or perhaps compensation for policy sacrifices elsewhere. Perhaps this just reflects the fact that Lib Dem fiscal policy was more clearly stated, and maybe more thoroughly formulated, than its Conservative equivalent.
So bad is the situation that tax rises and spending cuts really have to go hand in hand, which explains why the Conservatives are going to have to move away from their usual tax-cutting agenda. Given history on this subject, predictions of a VAT rise appear well-founded, as we have seen these in the late 70s and early 90s from previous Conservative Chancellors faced with problems balancing the books in a recession. So 20% VAT looks very much on the cards from (say) 1st August, particularly as it has the advantage of an almost immediate cash impact, unlike direct tax changes which would probably have to be deferred until April 2011.
Thus fiscal policy will be driven more by the extremity of the financial situation than party political dogma, which to a large extent makes it futile to try to attribute particular tax policies to specific coalition partners (not that this will stop the media trying to do so, no doubt).
The most interesting part of the Lib Dem tax agenda, at least for a professional working in the field, is the proposal to increase the income tax personal allowance to £10,000, which it appears will be phased in over the life of the Parliament. The idea is to take several million people out of the tax system altogether, thus reducing some of the formidable administrative burden on HM Revenue & Customs, and freeing up resources to mount an effective pursuit of tax evaders. This is long overdue, as initiatives such as the Offshore and Liechtenstein disclosure facilities have demonstrated that the manpower available to HM Revenue & Customs is woefully inadequate to match the flood of information now available on the subject of offshore bank account holders. A purge of the 'black economy' within the UK is also long overdue.
I see these anti-evasion steps as essential to prepare the ground for what I anticipate will be another plank of coalition tax policy pre-figured in the Lib Dem manifesto, namely an attack on tax avoidance. The specific form anticipated by the Lib Dems in this respect is a general corporation tax anti-avoidance rule, as operated successfully by Australia, among others. In general terms this will state that tax avoidance action taken by corporate taxpayers will be ineffective unless sanctioned by HM Revenue & Customs, either retrospectively (if the taxpayer wants to take the risk) or by way of an advance clearance procedure (paid for by the taxpayer at commercial tax advice hourly rates) if the taxpayer craves certainty as to the outcome of its actions.
I see this primarily as a shot across the bows of those arch-tax avoiders, the banks, who are likely to elicit zero public sympathy if they whinge about this infringement of their freedom to implement highly artificial schemes to keep more of their rapidly burgeoning profits out of the hands of the taxman. Thus it has the potential, at that level, to be that rare thing, a popular tax raising measure. To be fair, high level tax avoidance activity is not the sole preserve of the banks, but they are its highest profile exponents.
However, once the principle of a general anti-avoidance rule is in place, there would be a grave temptation to expand upon it. In this respect there is at least one, and realistically three, elephants in the tax avoidance / tax mitigation room which, at a much more modest level, are depriving the government of £billions of potential tax revenue. Will the coalition have the political will and the fiscal ingenuity to mount an effective challenge in these areas, or indeed will the extremity of the financial situation force them to do so?
The aspect of 'everyday' tax avoidance that was acknowledged by the previous government, but in no way effectively dealt with, was income splitting between spouses. I characterised Angela Eagle's response to the Arctic Systems decision in 2007 as the equivalent of King Lear's speech of empty defiance to his evil daughters:
"I will do such things --
What they are, yet I know not: but they shall be
The terrors of the earth!"
and so it proved, as the draft legislation introduced to counter income splitting proved to be woefully inadequate to the task, let alone potentially hugely unpopular with that large chunk of the electorate which finds itself, by accident or design, in business on its own account. There is a lot of tax revenue to be generated in this particular political minefield, but it will not be easy money to gather, either politically or intellectually.
Closely akin to the income splitting issue is the whole question of tax-driven incorporation. Despite the demise of the laughable 0% corporation tax rate (a massive driver of this tendency) and the basic rate of income tax falling below the small companies rate of corporation tax, there is still significant tax advantage to be gained for even a moderately profitable business from trading as a company as opposed to a partnership or sole trade, particularly if the business can afford to reinvest some of its profits as opposed to distributing them all. Now it is possible to mount a tenable argument that limited liability is sufficient reward for trading through a corporate vehicle, and that the choice of business vehicle should be fiscally neutral. Use that as an argument to raise taxes on close companies (national insurance on close company dividends / a higher corporation tax rate for close companies?) and you again find yourself in potentially lucrative, but politically highly charged, tax-raising territory.
The third area where the government leaks significant amounts of tax is that of self-employed categorisation. The irony of this particular situation is that it is largely driven by government departments, in desperate need of expert input on various matters but determined not to burden themselves with highly paid and hard to dispose of employees. Their solution has been to engage consultants on a self-employed basis, who no doubt quite often engage in incorporation and income splitting for good measure. The tax and national insurance loss as a result is highly significant.
Talk of laughable government initiatives such as the 0% corporation tax band brings us neatly to IR35. Other government departments having opened the Pandora's box of consultancy, the Treasury desperately tries to jam it back in the box with a spectacularly ineffective and misjudged piece of legislation. The concept is vaguely sensible; where an intermediary is placed in what would otherwise be an employment relationship, ignore its existence and tax the relationship as if it were an employment. But the means of implementation is clumsy and complex, it is easy to avoid (and thus ineffective), and worst of all tax faults, it is perceived to be unfairly targetted at a specific group of taxpayers.
For, instead of telling other government departments to stop engaging consultants, the Treasury chose to apply the tax charge to the consultants rather than the government departments, and chose to apply IR35 pretty much exclusively to computer consultants, which is where the biggest issue lay with government subcontractors. Discriminatory taxation is not good taxation, particularly when it doesn't in fact succeed in 'doing what it says on the box'.
There is a massive flaw in IR35, and that flaw has nothing to do with tax and everything to do with employment law. Employment tribunals and the courts have established a number of basic principles of employment law, one of which is that there can be no employment relationship without a requirement for personal service by the employee.
Now taken to its logical extreme I guess that could mean that none of us need be an employee; simply insert into the employment contract a right for the employee to provide and pay a substitute and, hey presto, you have a contract for services and a self-employed relationship. The saving grace from the Treasury's point of view is that most employers want to know who will be turning up for work on Monday morning, and thus regard employers' national insurance as the lesser of two evils in this respect. But.........
The whole point of IR35 is to deal with the situation where the contractor places an intermediary company between himself and his customer. The contractor would be very poorly advised if the contract between the company and his customer said anything other than that the company will provide an appropriately qualified and experienced individual to undertake the work specified in the contract. He would be spectacularly poorly advised if the contract mentioned him by name at all, other than as the signatory on behalf of the company. On this basis, where is the employment relationship in respect of which the company is the intermediary? Where is the requirement for personal service by a named individual? That is the fundamental flaw in IR35.
So does the coalition have the political will and the fiscal dexterity to find an effective replacement for IR35? Again economic imperatives may cause this question to be answered in the affirmative, but again at what political cost?
The other imponderable aspect of these potential changes is the impact on the finances of the business community; is this economically a good time to close down their tax mitigation opportunities wholesale? Tricky business this Chancellorship!
Another factor in the fiscal decision-making process will be the newly-established Office for Budget Responsibility (hark, is that a new 'quango' I see being formed?), which will take fiscal forecasting out of the party political realm, and will make recommendations to the Chancellor about the easing or tightening of fiscal policy required by the financial situation. This seems to mirror Gordon Brown's far-reaching decision in 1997 to de-politicise the setting of interest rates, which had been a tremendous success in helping to secure relative economic equilibrium until the banking crisis rendered it temporarily irrelevant. And it might also serve as a useful let-out for a Chancellor faced with unpopular decisions on tax rises or spending cuts to be able to say "I had no choice in the light of the OBR's recommendations". In any case, anything that depoliticises vital economic and fiscal decisions seems to me to be a good thing.
So, finally, what of George Osborne as Chancellor? It is difficult to imagine a less promising set of economic circumstances for a Chancellor to inherit, but then, rather like new football managers, the chances are that it is a job that you inherit precisely because there are big problems to solve - not too many managers get sacked at the top of the League, and not too many governments lose elections when all in the economic garden is rosy. It is interesting to contrast in this respect Kenneth Clarke's legacy to Gordon Brown with Alistair Darling's to George Osborne.
Given Mervyn King's gloomy prediction that whoever won the 2010 General Election would be out of power for a generation (either because they failed to take the necessary drastic action or because they took the necessary drastic action) Mr O has the odds stacked against him, and in fact those very odds may make it difficult to accurately judge his performance as Chancellor fairly. Anyone who has read my previous blogs will have recognised that I am not a fan of Mr Osborne on the basis of what little I know or have seen of him, but I would be only too pleased to be proved spectacularly wrong about him over the next few years.
Another interesting aspect, as I alluded to above, is the security of George Osborne's tenure at #11 Downing Street. Having got rather used to the idea of Gordon Brown as an immovable object at the Treasury (perhaps he wishes he had been rather more immovable with hindsight!) it came as a bit of a shock to find Alistair Darling's position in reputed peril last year, and given the high stakes involved it is difficult to see Mr Osborne's friendship with David Cameron counting for much if he doesn't cut the mustard as Chancellor. Also, whereas in Gordon Brown's day it was difficult to impossible to name an alternative Chancellor, we now appear to be spoiled for choice (I know Ken is probably a bit old for the job, but that leaves two very strong candidates, not to mention the likes of Michael Gove). So no pressure on George Osborne then!
All in all Mr Osborne may feel that he is in the position of the victim of the ancient Chinese curse "May you live in interesting times!" Interesting they will certainly be for tax-watchers in the UK, but with so much hanging on the coalition's handling of the economy they could also be fairly frightening for a while. My vain ambition to be Chancellor remains very much on the backburner; not a good time to take on the job, I fear!
Mark Simpson
17 May 2010
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