Budget 2021: the questions on the Chancellor's mind

24 February 2021

There are three big questions about fiscal and tax policy which Rishi Sunak might begin to answer in his Budget speech on 3 March.

How big is the fiscal deficit that needs to be addressed?

First, how big is the fiscal black hole that he has to address. There will inevitably still be some uncertainty about this in that it will depend upon the nature of our economic recovery post-lockdown but the Office for Budget Responsibility will set out its forecasts for the public finances and the Chancellor can be expected to give some indication as to what he considers to be an acceptable level of borrowing. The gap between these numbers – probably in the region of £40bn-£60bn – is the scale of the challenge.

What is the timeline for addressing the fiscal deficit?

Second, the Chancellor will have to decide when he is going to address this. He is under little market pressure to do so immediately and most economists argue against early action. However, deficit-reduction measures become harder for a Chancellor as we get closer to a general election. He will worry that if he does not act now, he will be unable to do so for some time.

How will the Chancellor stabilise public finances?

Third, the Chancellor will have to set out how he intends to put the public finances on what he sees as a sustainable footing. Pressures on public spending are likely to be strong in the next few years so it is likely that taxes will make a very substantial contribution to meeting this objective. If the Chancellor has concluded that he needs to act quickly to stabilise the public finances, he will have to set out how he is going to do that.

Potential tax rises

The Chancellor’s task is made all the harder by the “tax lock”, set out in the Conservatives’ 2019 manifesto, not to increase the rates of income tax, national insurance contributions and VAT. These three taxes constitute 64% of government revenue. Raising substantial sums without increasing the rates for these taxes will be challenging, although some revenue could be raised by freezing thresholds and allowances.

The most likely tax to rise is corporation tax. The rate of corporation tax has fallen from 28% in 2010 to 19% now. Indeed, it was due to fall to 17% until Mr Sunak reversed this reduction in his first Budget a year ago. The absence of criticism of this measure may encourage him to go further and – contrary to the trend of most western economies in the last forty years – increase the rates.

The other tax to look out for is capital gains tax (CGT). It has been heavily trailed as a tax from which more revenue could be raised, either by reforming reliefs or allowances or by increasing rates. One suggestion is that the CGT rates could be aligned with income tax rates. However, CGT rates of 45% may well be beyond the revenue maximising point. Recent press speculation has suggested that the Chancellor may defer any significant changes to CGT until a later date, but an early announcement cannot be entirely discounted.

Pension tax relief reform is also seen as a possible source of additional revenue although, again, this may be deferred until later in the year. The Treasury came close to a fundamental reform of pension tax relief in 2016 but the complexity of any such reform should not be under-estimated.

What about more radical reforms? The government has responded coolly to the proposal of a one-off wealth tax, as advocated by the Wealth Tax Commission. An alternative might be a “solidarity tax” constituting a surcharge on existing income tax and NICs payments, as advocated by Lord Macpherson, former Permanent Secretary to the Treasury. However, it is likely that any radical reforms would only be announced after the government had carefully prepared the ground.

In all likelihood, we will not get full answers to the three questions set out above but by the time the Chancellor sits down at the end of his Budget speech on 3 March, we should have a much clearer idea on the direction of travel.