From blame to pain: What a tax grab could look like

As expected, chancellor Rachel Reeves has made full use of the chance to pin responsibility for the difficult decisions she is being “forced” to make on the previous government. In her first speech to the House of Commons in her new role, she squeezed out a thick cement of blame, and laid it down as the foundation for what we should expect will be a painful assault on tax and inherited wealth in the Budget on 30 October.

No details were given – the purpose of the statement was to accuse and to signal what is coming next. Regardless of the ensuing political squabble around the facts, or how other decisions, such as above inflation public sector pay rises, will contribute to the fiscal black hole, the truth is that the nation’s finances are in an abysmal state, and if pensioners are being asked to do their bit, everyone from the middle classes upwards will be conscripted next.

Based on Reeves’ previous comments as shadow chancellor, and her rash promise that income tax, NI and VAT will not be increased, that leaves four potential areas for pillaging, which, pleasingly for Labour, would align with the party’s redistribution-for-equality goals.

First, capital gains tax (CGT). There are many who are irate that capital gains are taxed at a lower rate than earnings, and that assets passed on at death see their CGT liability wiped (to prevent double taxation).

Aligning CGT rates with income tax would mean additional-rate taxpayers would face a charge of 45 per cent (48 per cent in Scotland) on realised gains above the £3,000 allowance. Currently, the top rate is 28 per cent. Chris Etherington at RSM points out that removing the CGT uplift on death would result in some gains, for example on unlisted shares, being taxed at a rate of 52 per cent. But incentives matter. Taking on risk, carrying out research, committing time and effort may lose its appeal if you are required to hand over more than half of the returns.

Inheritance tax (IHT) could also be a target given Labour’s antipathy to inherited wealth. Massively shrinking the residence nil-rate band, so that ordinary families still benefit but richer ones don’t, is one option. A more radical plan might be to turn the whole system on its head and bring in an individual inheritance allowance. Any overhaul on IHT might also lead to stricter lifetime gifting allowance to close off an ‘escape’ route.

Treasury officials, whose own public sector pensions are generous and guaranteed, tell every government how expensive pension tax relief is and how much cutting it would save. Most ministers however resist the temptation given the importance of encouraging people to save for retirement, the unfairness inherent in taxing pension savings twice (on the way in and on the way out), and the sheer inequity of making it even more difficult for private sector employees to achieve a decent income in retirement while the gold-plated pensions of public sector employees remain shielded.

If Reeves is brave enough to open the can of worms that is pension tax relief, it may prove to be difficult to administer, incredibly unpopular and could even, says Tom Selby at AJ Bell, risk “blistering rows” with public sector workers who might be asked to repay thousands of pounds of tax relief.

A much easier option from her perspective would be to axe the ability to pass on pension pots tax free; to cap or even ban the 25 per cent tax-free lump sum and to reduce the annual allowance to £40k or less. Gary Smith at Evelyn points out that many people use the lump sum to pay off their mortgage. Alternatively, national insurance could be applied to pension income. Most controversial of all would be to introduce means testing of the state pension.

A fourth strand that Reeves might be tempted to pull on is business relief, the shelter that prevents family businesses and farms being sold, or loaded up with debt, on the death of the owner, and one that provides support for small companies that raise finance from individual investors. The Institute for Fiscal Studies thinks the current scheme unfairly benefits rich investors and therefore should be scrapped.

All of the above are suppositions. But investors must expect to be clobbered one way or another, and regardless of the consequences. A failure to encourage investment in businesses and savers’ own future financial security would be a terrible mistake, but such warnings may count for nothing in the dash to fill in the black hole.