The coalition government has restive backbenchers on both wings seeking to fast-track tax reforms that promote fairness and create a platform for economic growth.  These are rarely complementary agendas, so the Chancellor will have a difficult job satisfying their demands.

Despite recent downgrading of the UK’s outlook ratings, the Chancellor will be able to announce progress in the phased reduction of the fiscal deficit, and so the opportunity in the middle of the parliament presents itself, allowing Osborne to focus upon further authentic tax reforms for the remainder of this parliament. This will hopefully permit the UK to retain its AAA rating in the absence of a cataclysmic event out of his control in the European or Global economies.

Individual Taxation
The pledge that no one will pay income tax until they earn £10,000 is the central personal tax policy within the Coalition Agreement, so it can be predicted with confidence that the personal allowance will be raised again, perhaps by a further £1,000 to £9,105 for 2013/14.

The Chancellor’s dilemma is how to fund this costly pledge.  Another reduction in the threshold at which higher rate tax kicks in would be an added blow to the ‘squeezed middle’; a 40 percent tax rate applied to individuals earning less than twice average earnings is increasingly unsustainable, especially with the current proposals for the child benefit withdrawal for higher rate taxpayers.  In our view, the Chancellor must not again reduce the basic rate tax band, already much too low at its current £35,000.

The Chancellor and most Conservative backbenchers regard the 50 percent top tax rate, applied to incomes over £150,000 per annum, as economically damaging and, in particular, a disincentive for both entrepreneurs and global corporations to establish businesses in the UK. Questions continue to be raised about the level of income tax actually collected by the 50 percent rate, as it is influenced by behavioural aspects, such as possible executive relocation from the UK and the level of dividends from owner managed companies to their shareholders, which are difficult to measure.

A feasible political roadmap for the Chancellor to fast-track the abolition of the 50 percent rate might be a combination of:
•    reducing all personal tax reliefs (excluding charitable donations) to basic rate only;
•    significantly increasing the basic rate tax band;
•    introducing a further income tax band of, say, £10,000 at a 30 percent rate, and
•    introducing additional higher council tax rate bands to head off certain of his Coalition partners wish for a ‘mansion tax’.

In addition, the Chancellor should recognise the need for additional targeted measures to restrict wholly artificial stamp duty avoidance on residential property.  This would address the widespread perception of unfairness that opportunities could remain for purchasers of high value residential properties to mitigate their liability that are unavailable for more modest properties.

Business Taxation
BDO predicts that the reduction in the main rate of corporation tax may well be accelerated.  The Chancellor must be again tempted to announce a 2 percent reduction to 24 percent with effect from 1 April 2012, and a further 2 percent reduction to 22 percent from 1 April 2013.

This would enable the coalition government to be able to demonstrate its commitment to creating one of the most competitive corporate tax systems within the G20 by delivering and, indeed, exceeding its previous targets of 1 percent annual reductions until a rate of 23 percent is reached by 1 April 2014.  We would not dismiss a commitment by the Chancellor to target a flat 20 percent corporation tax rate by the end of this Parliament.

The reform of the Controlled Foreign Companies (CFC) rules is another key measure within the Treasury’s corporate tax reform package.  Measures to restrict the impact of these rules in order to encourage overseas expansion by UK-based groups will be confirmed in this Budget.  We anticipate that there could be more proposals to ease the practical implementation of the new rules, which are fiendishly complex to interpret but, fortunately, only affect a small minority of UK groups.

The Chancellor is clearly walking a political tightrope and it remains to be seen whether the Budget can placate both wings of the Coalition.  This political pressure can only add to the difficulty of fashioning authentic fiscal reforms that stimulate growth within the overarching constraints of reducing the fiscal deficit to sustainable levels. The efficacy of the actual Budget proposals will need to be set against these tight constraints.

Image — Britain’s Chancellor of the Exchequer George Osborne leaves number 11 Downing Street in London March 20, 2012.  REUTERS/Luke MacGregor

-Thomas Story is tax director at BDO LLP. The opinions expressed are his own.  Join Reuters for a live discussion with guests as UK Chancellor George Osborne makes  an emergency budget statement at 12:30 p.m. British time on Tuesday, June 22, 2010.-

Ten key tests by which Chancellor George Osborne will be judged when he delivers the emergency budget on Tuesday:

1. Do the tax measures make a significant contribution to reducing the fiscal deficit?

The Chancellor is caught on the horns of a dilemma with the promise of various tax cuts contained in the coalition agreement needing to be offset by larger tax rises in the emergency budget to help plug the gap in the government’s finances.  However, this may allow some targeted tax cuts to be introduced from 2011 but only in small steps as the economy improves.

2. Will the total tax take be re-focused towards indirect taxes upon consumption and away from taxes upon income and profits?

It would be a massive surprise if there was no announcement of a significant VAT uplift on Budget Day. On current projections VAT is anticipated to bring in 78 billion pounds for 2010-11 and a rise to 20 percent could add up to a further 11 billion pounds. Given that the Chancellor is unlikely to have an opportunity to raise VAT again this parliament, he may be tempted to raise the rate even higher with a promise to reduce it once the deficit is under control.

3. Which indirect stealth taxes could be raised whilst attention will be focused upon the increased VAT rate?

In essence, there are two classic forms of stealth tax: increases in low profile taxes; and failing to increase rates and allowances in line with inflation. Both forms of stealth tax can be anticipated, although the lion’s share of tax rises will need to come from income tax, national insurance or VAT. Only these three taxes could sufficiently raise the aggregate amount of tax to make a substantial impact in the context of the 150 billion pounds plus fiscal deficit.

4. How will the emergency budget ensure that Britain’s competitive position for global businesses been protected, and, indeed, enhanced?

Reducing the fiscal deficit must be the number one priority for the coalition government, but it is hoped that the emergency budget will be an opportunity to introduce a number of broad business-friendly measures that will help to boost the business economy to deliver the economic growth that is ultimately necessary to fund the government’s ongoing commitments to essential frontline services and key initiatives.

5. To what extent will the foundations have been laid for tax cuts in 4 to 5 years’ time before the next election but after the fiscal deficit has been slashed?

When this emergency budget is recalled in five, 10 or 20 years time, the acid test of its efficacy will be whether it has set out a robust framework of spending reductions and, unavoidable targeted tax increases which enabled the economy to be rebalanced towards private sector led growth, underpinned by a simpler, flatter taxation system with lower marginal tax rates.

6. Where might the Chancellor bow to sectional and vested interests by continuing with reliefs that erode the scope for aggressive cuts in both business tax rates and personal tax rates in the future?

The coalition government has made a commitment to reform the corporate tax system by simplifying reliefs and allowances, and by tackling avoidance, in order to reduce headline rates. This can only be achieved by standing up to the myriad of special interest groups which will plead that their sector is a special case for retaining (or even extending) particular, over-targeted and expensive tax reliefs resulting in unnecessarily high business and personal tax rates.

7. Will the budget measures represent a first step towards a simplified taxation system?

It would be all too easy for an incoming government to view tax simplification as a worthwhile but not pressing technical exercise and defer any action until later budgets. This would be a serious mistake due to the magnitude of the fiscal and economic challenges and would represent a significant missed opportunity.

8. How will the tax changes protect and incentivise those working part time or on low wages?

The principle of reducing marginal tax rates on lower paid workers should entice more individuals into the labour force. It would bring in additional tax receipts, whilst simultaneously reducing the relative incentives for individuals to rely on costly benefits. However, care must be taken that the cost of increasing the personal allowance is not balanced by tax increases. This would directly, or indirectly, damage the capacity of businesses to provide the employment opportunities required to achieve the benefits of this objective.

9. What percentage of the total tax take does HMG consider should come from corporation tax and other taxes which fall principally upon the business sector?

The Lib Con Coalition Agreement makes it clear that they will consider proceeding with the increase in the employers’ national insurance threshold as part of a programme of taxation reform “to make it more competitive, simpler, greener and fairer”. It is hoped that the Government has recognised that the headline rate of corporation tax is increasingly uncompetitive when compared to our near European neighbours.

10. Does the Chancellor consider the tax take from CGT and IHT should rise in comparison to the GNP, track the GNP or fall in comparison to the GNP?

A clear policy should be established for this Parliament to enable businesses and individuals to plan with some certainty the future tax consequences of their investment transactions and family arrangements.

Thomas Story is tax director at BDO. He will participate in a Reuters Budget live blog at noon GMT on Wednesday, March 24, 2010. Please tune in and join the discussion.

The March 2010 Budget, to be held next Wednesday, will inevitably be highly political as it is effectively the starting gun for the general election campaign. In this context, further significant fiscal measures to tackle the 178 billion pound government deficit will almost certainly be postponed.

Whatever the political colour (or colours) of the next Government, tough decisions will need to be taken in a second Budget within months of the general election. Individual taxpayers and businesses should steel themselves for a frustrating period of uncertainty as party politics overshadow the uncomfortable fiscal imperative to raise significant additional tax revenues as a contribution, alongside significant public spending cuts, to curb the unsustainable fiscal deficit.

In the wake of the credit quake we have seen a 42 billion pounds fall in tax collections. This leaves the Chancellor very little room for any tax cuts to curry favour with voters but, equally, he dare not raise taxes significantly in a Budget held only a few weeks before a general election. We can expect a ‘Phoney Budget’ on 24th March with any hard hitting, significant tax raising measures deferred until the second 2010 Budget.

So what might the March Budget have in store?

Tax rates and allowances have already been announced in the November 2009 Pre-Budget Report and these will almost certainly be confirmed in the Budget. The Chancellor might be tempted to augment the 50 percent income tax rate for high earners with a “super tax” of, say, 60 Pre-Budget Report on income over 1 million pounds, but this is an outside bet.

A cut in the headline rate of corporation tax is a possibility, to outflank the Conservatives, who have championed this measure. This would almost certainly have to be funded by a reduction in tax reliefs such as capital allowances. Other significant fiscal reform is unlikely, as the Chancellor will be fearful of frightening the horses so close to the General Election.

The real sting in the tail will come in a post-Election June/July 2010 Budget when the Chancellor, no matter which party he represents, will face some stark choices.

There will undoubtedly be tax rises, whatever the outcome of the election. The focus will be on the taxes that hit us where it hurts; Income Tax, National Insurance and VAT as only these taxes have the potential to raise large enough amounts to put a significant dent in the 178 billion pound deficit.

I expect that VAT will rise to at least 20 percent regardless of the colour of the government.

In conclusion, I fear that the March 2010 Budget is bound to be more about ‘Punch ‘n’ Judy’ politics rather than important fiscal reforms. Sadly, it is almost unavoidable that taxes will rise after the election, in addition to cuts in government spending, irrespective of the outcome. I am convinced that some tax rises are much more damaging than others and this should be a key area of the electoral debate. However, it is almost inevitable that we will need to wait until a second Budget to find out exactly where the tax hikes will occur.