Investment - Articles - Starmer lays groundwork for tax rises in October Budget

 The prime minister repeated his pledge that income tax, National Insurance and VAT would not be increased, indicating that the wealthy would be the worst hit by any tax rises

 Last month chancellor Rachel Reeves announced that Winter Fuel Payments would be cut for many pensioners. What else could be on the table at the Budget on 30 October?

 Laura Suter, director of personal finance at AJ Bell, comments: “The prime minister took to Downing Street’s notorious rose garden in a speech today, making clear the heavy pruning that’s needed with government finances and laying the groundwork for tax rises as part of a ‘painful’ Budget on 30 October. While the speech’s key points largely mirror those made by chancellor Rachel Reeves in July, Starmer still struck an ominous tone. Growth remains the priority for the government though it is anything but a rosy economic picture, with the £22 billion ‘black hole’ supposedly identified when Labour came into power almost two months ago.

 “In perhaps the most compelling indication yet of which taxes could be on the table in the October Budget, Starmer said that those with the ‘widest shoulders should bear the heaviest burden’, adding fuel to rumours around increases to capital gains tax and inheritance tax, while also doubling down on Labour’s manifesto commitment not to tinker with income tax, National Insurance or VAT. His comments will also reignite the rumours of a specific ‘wealth tax’ to be paid by the wealthiest in the UK. This could just take the form of increasing existing taxes for investors and the top earners, or it could be a new, standalone tax on those with the biggest pockets.

 “Unsurprisingly, the record of the previous government was dragged over hot coals as Starmer defended last month’s decision to means test Winter Fuel Payments from this year. However, laying the blame at the door of the Conservatives is unlikely to assuage the concerns of the public over exactly which taxes could be subject to increases or how that may affect the nation’s finances as we head towards winter. Though it is always wise to ignore the rumours and to only make decisions based on the current tax system, we look at the tax changes that could be under consideration in the October Budget.”

 Where might Labour turn for tax rises?

 Income tax

 AJ Bell personal finance director, Laura Suter: “While the chancellor pledged in the election campaign not to raise the rate of income tax, that doesn’t preclude extending the current freeze on thresholds, which is tantamount to raising tax by the back door. It was a tactic used by the Conservatives to raise taxes on working households, with rising wages at a time of high inflation providing a super-charged stealth tax on earnings. The effect is muted somewhat when wage rises are lower, which is to be expected as inflation comes down, but it’s still an easy way to boost tax revenues.”

 Capital gains tax (CGT)

 AJ Bell personal finance director, Laura Suter: “Having ruled out increases to some other taxes, capital gains tax (CGT) might appear like an obvious place for the government to make changes and generate more tax revenue. The most radical option is equalising CGT rates with income tax – which would represent a huge tax increase for investors. The Office for Tax Simplification, now disbanded, has previously argued the CGT exemption was too high and that the disparity between rates of CGT and income tax distorts decision making. The CGT free allowance has been slashed in the past two years as Jeremy Hunt sought to balance the books, but that doesn’t rule out further tax increases.

 “However, it may not be the cash cow that many think it is. The government’s own figures show that a big increase in CGT rates could backfire and actually lead to lost revenue for the government. For example, raising both the lower and higher CGT rates by 10 percentage points, to 20% and 30% for non-property gains, would result in a total loss of £2.05 billion for the Exchequer by 2027/28. That’s because while the rates are higher, investors would be expected to change their behaviour to mitigate paying the tax.

 “An alternative would be to get rid of some of the CGT tax breaks for businesses, where business owners selling their company benefit from a lower rate of CGT. Raising this rate from 10% up to 20% to equalise it with standard CGT rates is estimated to generate £710 million for the government by 2027/28 – but it’s clearly not a move that will be popular with entrepreneurs.

 “CGT being wiped out on death also creates an incentive in some cases to hold onto assets so they are taxed as part of the estate under IHT, potentially paying less or no tax. But if the government scrapped this tax break, there would likely need to be some allowance made to account for inflation. Otherwise people who have owned investments for a very long time would be severely punished.”

 Dividend tax

 Dan Coatsworth, investment analyst at AJ Bell: “The previous government has already cut dividend tax allowance to the bone, going from £5,000 to the current £500. The big question is whether Labour is prepared to go any deeper.

 “HMRC is expected to collect almost £18 billion from dividend tax in the current tax year so it is already a meaningful source of revenue. While slashing the allowance, perhaps to £250, cannot be ruled out, the new government would be incredibly unpopular with investors if it reduced the dividend allowance any further.

 “Another option would be to raise the rate of dividend taxation, although there’s only so much room for manoeuvre with tax rates on dividends already very close to matching income tax rates for higher and additional rate taxpayers.

 “The government will likely tread carefully here. Labour wants to encourage investment into the UK stock market and create a more vibrant place for British businesses to access growth capital. Therefore, taking even more of investors’ returns as tax would mean shooting itself in the foot.”

 Inheritance tax (IHT)

 AJ Bell personal finance director, Laura Suter: “Often cited as the UK’s most hated tax, despite only being paid by a small proportion of the population, the chancellor could set her sights on raising money through IHT. At 40% it’s already one of the highest tax rates, so it’s unlikely we’d see a headline rate increase. What’s more likely if Ms Reeves did want to change this tax is cutting allowances or whittling away certain reliefs to increase the amount some estates pay.

 “A couple leaving their main residence to their children could potentially shelter a £1 million estate from inheritance tax, thanks to both the nil-rate band and the residence-nil-rate band – but either of these could be cut. Another option is taking a red pen to the reliefs given to businesses or to gifting rules – although these aren’t overly generous anyway.”

 Pensions

 Tom Selby, director of public policy at AJ Bell: “Pretty much every major fiscal event over the last two decades has been preceded by feverish speculation that the axe could fall on pension tax perks. There are broadly three different avenues the chancellor could pursue if she wanted to raise cash from savers – but each comes with significant practical and political challenges.”

 “Most controversially, the government could move to restrict people’s entitlement to tax-free cash when they access their retirement pot. Currently, most people can take up to 25% of their fund from age 55 tax-free, with this minimum access age due to rise to 57 in 2028. The amount of tax-free cash most savers can take over their lifetime is capped at £268,275. Starmer and Reeves could, in theory, lower the amount of tax-free cash Brits are entitled to – or even abolish the entitlement altogether.

 “However, this would be deeply unpopular and fundamentally undermine wider government efforts to boost long-term investing, including in UK Plc. It would also inevitably be hugely complicated, as those who have already built-up entitlements to tax-free cash under the existing rules would almost certainly need to be protected against a retrospective retirement tax. Furthermore, the overall amount people can access tax-free has already been scaled back significantly over the last 14 years, and if the current figure remains frozen, it will continue to be eroded in real terms.

 “The most common pre-Budget pension tax relief speculation centres around the future of higher-rate pension relief and the potential to introduce a flat rate of pension tax relief. At the more extreme end, this measure could see pension tax relief restricted to the basic rate of 20% for all, with advocates suggesting this could raise billions of pounds of extra revenue for the Treasury.

 “However, as with most radical pension tax changes, introducing a flat rate of relief is much easier said than done. A huge chunk of any potential savings to the Treasury from a pension tax relief raid would come from defined benefit (DB) schemes, the majority of which now reside in the public sector.

 “If a flat rate of pension tax relief below 40% were applied on these schemes, the only way to ensure the correct level of tax relief was applied to contributions from higher and additional-rate taxpayers would be to hit those members with a tax charge likely running into thousands of pounds. This would therefore risk opening up a blistering row with NHS staff and civil servants at a time when many public services are already stretched to breaking point.

 “Lastly, the tax treatment of pensions on death will be viewed by many as low hanging tax fruit ready to be picked. Under existing rules, it is possible to pass on your retirement pot completely tax-free to your nominated beneficiaries if you die before age 75. If you die after age 75, any inherited pension is taxed in the same way as income. Crucially, pensions usually don’t form part of people’s estate for inheritance tax (IHT) purposes.

 “This is undoubtedly a generous set of rules and something which could easily be reviewed by the new government. However, as is often the case with pensions, applying any new tax on death – or bringing pensions into the IHT net – would come with substantial challenges.

 “The biggest of those would be around how to treat people who have made decisions about their retirement pot based on the pensions death tax rules as they are today. There will, for example, be lots of people who chose to transfer defined benefit pensions into a defined contribution scheme in part because they wanted to prioritise passing money on tax efficiently to loved ones. If all of a sudden that money became subject to a new pensions death tax, those people would, understandably, feel like the rug has been pulled from under them. It is therefore possible a complicated protection regime would be needed to ensure people are not subject to unfair and arguably retrospective tax measures. This would inevitably reduce the money the Treasury could potentially raise from such a move.”