No increases in tax rates, but what about the tax base?

Tax – the amount, and who it falls on – remains an important political issue. The UK government currently brings in about £1 trillion of tax revenue each year, about 40% of GDP.

While we await the full manifestos for the 4 July 2024 general election, the major political parties have announced no increase in the rates of income tax, national insurance contributions (indeed, most say they want to reduce this so-called “jobs tax”), VAT or corporation tax. So that is about three quarters of the government’s tax revenues that will not increase.

Or is it that simple?

What about the taxes that have not been mentioned, such as capital gains tax, inheritance tax, stamp duty land tax, fuel and tobacco duties, council tax, business rates, and 101 smaller taxes and duties?

And as any good tax adviser knows, tax rates are only half the story. Tax revenues are a product of tax rates applied to a tax base.

So, if rates are fixed, what is happening to the tax base? What about reliefs and thresholds?

Recap on tax rates

Just as a reminder

• Income tax is charged at progressive rates of 20%, 40% and 45% on most income (but slightly lower rates of 8.75%, 33.75% and 39.35% for dividends).
• National Insurance contributions (NICs) are paid by employees at rates of 8% and 2%, by employers at 13.8%, and by the self-employed at 9% and 2% (with the NICs rates stepping down at the same point income tax moves from the 20% basic rate to the 40% higher rate, so in effect employment income is taxed at rates of 28%, 42% and 47%).
• The standard rate of VAT is 20%, but some goods or services bear 5% VAT, and others are zero-rated or exempt.
• The main rate of corporation tax is 25%, but small companies pay the 19% rate.

And to explain how we ended up here:

• The additional rate of income tax was introduced at 50% in April 2010, and cut to 45% in April 2013.
• The rates of NICs increased in April 2011, and temporarily increased in 2022 by the short-lived “social care levy”, but then cut back in the last two “fiscal events” before this election.
• The standard rate of VAT rose from 17.5% to 20% in 2011.
• Corporation tax gradually fell over the decade from 2008 to 2018 from 30% to 19%, but then increased from 19% to 25% in 2023.

Is it all about that base?

Given the continued straitened economy, demands for funding of public services such as schools and hospitals, immigration officers and defence, and little sign of the growth in productivity that everyone wants, what options does a new Chancellor of the Exchequer have to increase tax revenues, if many tax rates are fixed?

There were announcements on proposed reforms of “non-dom” taxation this Spring, which will result in the end of the remittance basis of taxation for non-domiciled individuals. The two largest parties, Conservatives and Labour, both support proposals under which individuals coming to the UK after at least 10 years of absence will be taxed on their worldwide income and gains after 4 years of UK tax residence, and will be subject to UK inheritance tax on their worldwide estate after 10 years of UK tax residence. That is one way to expand the UK tax base, by abolishing exemptions. (See our briefing on ‘The end of the current ‘non-dom’ tax regime – what has been proposed?‘)

Another way to increase the tax take is through the restriction or erosion of reliefs. The annual exempt amount for capital gains tax was cut from £12,300 in 2022-23, to £6,000 from April 2023, and to £3,000 from 6 April 2024. The income tax personal allowance reached £12,500 in April 2019, and was frozen at £12,570 in April 2021. Current government plans would maintain that freeze until 2028. Even in 2024, inflation has eroded the value of that personal allowance by over 20%. The additional rate income tax threshold was set at £150,000 in April 2010 and actually cut to £125,140 in April 2023, while the higher rate income tax threshold has barely moved since 2010. Over 14 years, inflation has risen prices by almost 50%, so the thresholds are about a third lower than they would be with inflationary increases.

In summary, years of fiscal drag pull increasing numbers of people into higher rate bands. Holding tax allowances steady results in tax rises by stealth.

Changing the tax treatment can also expand the tax base and increase the tax take without changing headline tax rates. For example, abolishing the VAT exemption for private schools’ fees could increase the tax take by expanding the VAT base (although some would argue that any increase in tax revenues would be substantially offset by parents moving children to state schools). Similarly, the income tax base would increase if, for example, the carried interest returns achieved by private equity executives are taxed as income rather than as capital gains.

If a government were so minded, significant sums could also be raised by changing the way that tax reliefs work. For example, higher and additional rate taxpayers currently claim relief for pension contributions and charitable donations at their highest marginal income tax rates. Might a new government cap that tax relief at the basic rate, as was done for mortgage interest relief at source (MIRAS) in 1991 before it was eventually abolished in 2000?

What about other taxes?

And might we expect some movement in other less salient taxes? Will capital gains tax remain at 10% and 20%, roughly half the rate of income tax, or could the rates be aligned, as they were by Nigel Lawson in 1988? Might there be some movement on the 40% rate of inheritance tax fixed since 1988, or the nil rate band fixed since 2009? And if the rate is cut and the threshold is increased, might there need to be movement to cap important reliefs such as Agricultural Property Relief and Business Property Relief?

Politicians who currently have no plans to make changes of this sort might find they develop them as the need arises.