UK Fiscal Policy: Reflections on an Odd Couple of Months

After the revolution, the reaction.

After the turmoil caused by the now infamous mini-budget earlier in the Autumn, it became received wisdom that the Chancellor had one job to do on 17 November and that was to keep the markets calm.?He managed that by delivering a dour and austere Statement that was deliberately lacking in anything remotely radical or reforming.?

Now, a couple of weeks on, it’s time to reflect on where this leaves us in the near and longer term. It is a tale of enforced stability, and missed opportunities.

A quick recap of the Autumn statement measures

It is hard to believe, but in just a few short months the country has gone from being promised ￡30 billion in tax cuts to being given ￡30 billion of tax rises.?Those tax rises will send the UK’s overall level of taxation to the highest point ever.?

We saw the government keep to its core 2019 manifesto commitments as Jeremy Hunt managed to impose significant tax rises without increasing the headline rate of the three main workhorses of the tax system: national insurance, income tax and VAT.?But we saw a ream of stealth taxes for individuals in the form of frozen thresholds.?In an inflationary environment that will mean more and more people will be dragged into higher tax brackets.?

Most of the thresholds had already been frozen till 2025/26 by Rishi Sunak when he was Chancellor.?Jeremy Hunt has extended the freeze for a further two years to 2027/28, far beyond the next General Election.???Many of the difficult spending cuts that help the Treasury numbers add up have also been largely deferred until after 2024. ?

At first sight the picture for businesses looked quieter. Dig into the figures though and it is clear the changes that were announced are expected to raise significant tax revenue.?

The major announcement was an extension to the existing Energy Profits Levy for oil and gas producers to 31 December 2028, together with an additional 10% on the rate.??The government has also moved away from its previous policy that it would review the levy when oil prices settle back at historical levels.?There was also a new levy on certain electricity generators, a tax that again will stay in place until 31 December 2028.

These windfall taxes don’t look much like windfall taxes anymore.?Across the two levies the government expects to raise tax of ￡54billion.?

There were also some changes to the R&D rules, reducing the generosity of the regime for Small and Medium Enterprises, but increasing the RDEC rate for larger companies.?This might lead one to think that the changes were broadly revenue neutral but the reforms, which are described in the costings as ‘rebalancing the generosity of the reliefs’ are slated to raise ￡4.5 billion across the period to 2027/28.

Businesses will also bear the cost of one of the fiscal drag measures in the form of freezing the secondary threshold for employer national insurance contributions until April 2028.?This is expected to raise ￡25 billion over the period.

The picture gets tougher for business when you add in changes that are already in the pipeline.?The planned increase to the headline rate of corporation tax from next April is expected to raise ￡83 bn by 2027/28 and the introduction of the global minimum tax, Pillar 2, about ￡9 bn.

Much of the media coverage following the Autumn Statement has been about the fiscal drag effect on individuals of freezing the thresholds.?But the numbers show just how much the government is tapping business for extra revenues.?It is hard to imagine that it wasn’t that long ago that we were expecting a 17% corporation tax rate.?

Missed opportunities

The Autumn Statement was also a story of missed opportunities.?

It was bereft of any significant tax measure aimed at boosting investment.??The UK system already favours revenue spend over capital investment.?There was no announcement of a planned replacement for the super-deduction which ends when the corporation tax headline rate increases to 25% next year. The R&D changes overall are expected to be a revenue raiser for the government.?And whilst a case can be made for windfall taxes given the recent high energy prices, there will be no equivalent for electricity generators of the super-deductions introduced in the EPL, at least partly because the way the levy is calculated is different.

The announced investment zones lasted precisely 2 months in their original form.?We now know they will be refocussed, and previous expressions of interest will not be taken forward.?It is unlikely the direct tax benefits originally planned for investment zones will remain.?The intersection of the investment zones that survive with Freeports also remains unclear.

There were also precious few announcements about how the tax system will contribute towards wider societal issues such as net zero or levelling up.?

On net zero we have a few minor carrots and sticks.?The investment allowance within the Energy Profits Levy has been maintained at a rate of 80% for decarbonisation activities whilst it has been reduced for all other investment expenditure.?But overall there are relatively few incentives that encourage businesses to invest in the right technologies.??Even if you think the UK’s R&D tax regime is reasonable it doesn’t discriminate between green and non-green development.?There seems to be little strategy for how current revenue streams such as fuel duty will be replaced other than the announcement that electric vehicles will pay Excise Duty from 2025, which looks on the face of it like a move in the wrong direction.

Searching for a strategy

From conversations since the Autumn Statement I have been struck by the frustration of business leaders at the lack of strategic thinking about how the tax system can be used to deliver growth, boost investment and achieve wider societal goods.?

It is no secret that Rishi Sunak is sceptical that a low headline rate of corporation tax drives increased investment.?But a high headline rate combined with a broad base and few targeted incentives, which is what we have now, is neither one thing nor the other.?At the moment we are picking no winners at all.

We all understand that the Autumn Statement was about immediate stabilisation, keeping the markets happy, filling black holes and battening down the hatches ready for a hard winter ahead.??But we are left wondering what this government’s strategy is when it comes to tax policy making.

Using the tax system to boost investment and growth

In his Mais lecture in February 2022 Rishi Sunak, then Chancellor, set out some fairly depressing statistics for how the UK performs against its international OECD peers.?Capital investment by UK businesses averages just 10% of GDP, considerably lower than the current OECD average of 14%.?UK employers spend just half the European average on training their employees. Just 18% of 25-64 year olds in the UK hold vocational qualifications, a third lower than the OECD average.??And whilst other nations’ businesses have increased the share of GDP they devote to R&D investment by 50% in recent decades, UK business investment in R&D has stayed flat or even fallen.?Business spending on R&D amounts to just four times the value of R&D tax relief. The OECD average is 15 times [1]

He set out how he wanted to change that narrative, by building an economy in which fostered growth.?He described what he considered two false ideas about how to increase growth.?The first was that governments should spend more and do more.?The second was unfunded tax cuts that would ‘pay for themselves’.?Critically he acknowledged the importance of the private sector in driving economic change and he set out his plan under three headings: Capital, People and Ideas.

We have seen how the government intends to tap business for much-needed revenue.?Now we need to see how it will encourage the private sector to invest in capital, people and ideas.?Those are the right three words, but policy requires more than words. The UK’s attractiveness as a location for investment has taken a knocking over the last few months.?Let’s hope that the Spring Budget will not only be the start of warmer weather but also the occasion that the government uses to set out its tax strategy and provide some framework for businesses who are looking to make investment decisions.?

[1] The Office of National Statistics recently announced a change to its methodology for calculating business enterprise research and development (BERD) statistics leading to an increase in BERD over recent years.?This change would improve the comparative UK statistics quoted by Mr Sunak in his Mais speech.

Comparison of ONS business enterprise research and development statistics with HMRC research and development tax credit statistics - Office for National Statistics

Tim Sarson and Sharon Baynham