UK Budget 2021: Schrödinger’s Tax Hikes

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Are UK taxes going up or down? When Chancellor of the Exchequer Rishi Sunak unveiled the 2021 budget today, he said, “My goal is to reduce taxes. By the end of this Parliament, I want taxes to be going down, not up.” That mission statement capped a speech in which he presented a smattering of targeted tax cuts, including reduced beer and air travel duties, commercial real estate tax relief for brick and mortar businesses, a small reduction in bank taxes, expanded research & development corporate tax credits, and more relief for low-income workers who receive the country’s universal tax credit. He did not announce broad new tax increases—rather, he froze fuel duties and canceled a previously announced increase on some alcoholic beverages. Yet the nonpartisan Office for Budget Responsibility (OBR) estimates the UK’s tax burden will hit 33.5% of GDP by fiscal 2026 – 2027, the highest since 1951.^[i] (It sees public spending reaching 41.6% of GDP by then, the highest over a sustained period since the late 1970s.^[ii]) So … who is right? We would argue the correct answer is “both and neither of them,” which we also think illustrates why UK stocks have dealt fine with the prospect of a higher tax burden.

Yes, the ideas in Sunak’s speech technically cut taxes, scoring some political points—which is what this exercise has always been about, in our view. But these small measures follow personal and corporate tax increases passed over the summer and a previously announced hike of the national insurance contribution, which funds the National Health Service and other social care programs. The OBR estimates these increases will add £49.7 billion to the UK’s total annual tax burden by 2026, while the cuts announced today total a paltry £1.6 billion.^[iii] So, score a fact-check point for the OBR’s bean counters.^[iv]

But these are also just projections, and they are based on a number of assumptions. One big assumption: that all of these higher taxes will actually be in place five years from now. We have our doubts, and not just because of Sunak’s honestly I am going to cut taxes mantra. Rather, we suspect a lot of this is good old-fashioned politicking. The corporate tax hikes don’t take effect until 2023, which is an eternity in politics, leaving plenty of room for a rethink. The income tax hikes start next April, but there is another Budget scheduled for March, leaving the government plenty of wiggle room to change course. They will likely have plenty of motivation to do so, thanks to the presently high inflation rate, which is eating away at Brits’ real disposable incomes.

The income tax hike was something of a stealth rise—it left rates untouched but froze the tax band thresholds, which normally rise more or less with inflation. That means as cost of living and salaries rise over the next few years, many people will end up in higher tax brackets even though their living standards haven’t changed much—not a good look politically, especially if high inflation is the reason this happens. That could give the government incentive to delay the freeze. And delay it again. And again—scoring political points in the process.

Those political points are important because the next election looks likely to happen sooner rather than later. It is due by May 2024, but a bill to repeal 2011’s Fixed-Term Parliaments Act is wending its way through Westminster—it passed the House of Commons earlier this year and is now progressing through the House of Lords. If it clears the upper chamber, Prime Minister Boris Johnson will no longer need a two-thirds Parliamentary majority to call a snap election—he can merely ask the Queen to use her royal prerogative to dissolve Parliament.

Political observers think that could happen as soon as next year, giving Johnson and Sunak the opportunity to campaign on big tax cuts. They would almost have to, considering Labour Party leader Keir Starmer has already jawboned about cutting taxes, making tax relief likely to feature in his party’s manifesto. Lest you think a quick 180 by Johnson and Sunak seems odd, we would politely remind you that causing problems and then campaigning on solutions to fix them is among the oldest political tactics in the book.

As for UK stocks, this saga is a lesson in how markets work. By scheduling the corporate tax increase two years out, Sunak gave businesses time to plan accordingly—it wasn’t the sort of shock change that would cancel investments overnight. That also gave markets time to pre-price it before it started showing up in corporate earnings in 2023, sapping the surprise power when (and if!) that eventually happens. It also flipped the potential surprise power from negative to positive, which should limit the impact on risk-taking. If you know the law says the corporate tax rate will rise from 19% to 25% in 2023, you might not like it, but at least you can calculate the rate of return on a new investment and determine whether it is worthwhile. If political uncertainty means there is a chance the tax rate could end up being lower than that, then that is a bonus, not a reason to delay investment.

So overall, we view today’s announcements as politics as usual, not a reason to change your outlook for UK stocks for better or worse. For all the splashy headlines, the changes were only marginal. In our view, politics isn’t about to displace global sector and style trends as the main influence on UK returns.