UK Budget 2016 Predictions
We can’t say its nick of time but yes, UK citizens, economists and political parties of the country can literally feel the pressure build up as George Osborne – Chancellor of the Exchequer is prepping himself up for announcing the next budget. The announcement is due for 16 March, 2016. The announcement for the new budget publication date came from Mr. Osborne on December 1, 2015.
The upcoming budget will be Chancellor’s first staging of full budget. There are several conjectures already in place regarding the possible course that might be set for the UK economy on March 1, 2016. It is pretty clear that the budget will be based on Office of Budget Responsibility’s latest updates and forecasts. Many are speculating, and rightly so, the budget will have taxation as the central focus. Pension and inflexible surplus will also stay in focus.
The Issue of Inflexible Surplus and Taxation
Chancellor Osborne has already presented the autumn statement and emergency budget since he came to office after election victory in May. Interestingly, he managed to pull £27 billion surplus by cutting tax credits and welfare budget. He made it clear that he will take further severe steps and continue to take the same path so that when the parliament ends in 2019-2020, a surplus of £10 billion stays.
However, one needs to understand that £27 billion extra that was pulled was a result of some last minute forecast tweaks made by the Office of Budget Responsibility. Analysts and skeptics are wary of the fact that forecasts may not stay favorable for the coming years and the plans of the Chancellor may be knocked off-course. Simple reason being that surplus acquisition is completely dependent on migration levels, interest rates, inflation and wages predictions and such predictions can change over time.
Office of Budget Responsibility, which is an independent forecaster for the UK government says that in the course of 5 years that follows, immigration will continue to rise as already seen. Chancellor Osborne is apparently dependent on this forecast by the forecaster but there is a glitch. Home Office is planning on cutting down net migration drastically. If this happens, the forecast will no longer work.
Institute for Fiscal Studies or IFS, which is UK’s independent think tank says that the Chancellor’s aim of maintaining a budget surplus was based on the assumption that times will be normal. However, it may not always stay so and Mr. Osborne might have to undertake some seriously precarious acts of balancing.
Speaking further, IFS said that such balancing acts might call for things like spending cuts and rise in taxes with very little notice.
IFS is known for publishing an annual document known as Green Budget before the actual budget is announced every year. The Green Budget simply jots down all economic conditions and points out the challenges that are to be faced by the Chancellor. Speaking of the current ambitions of Mr. Osborne, the IFS says that the aimed surplus for 2019-2020 is purely inflexible and if the Chancellor somehow gets unfavorable forecasts from the Office of Budget Responsibility, UK may have to face some serious implications in terms of spending and taxes.
The IFS clearly stated that in last 60 years, UK managed to pull budgetary surplus only 8 times. Maintaining a surplus is a simple rule and comes with merits the real scenarios are inflexible and there will be costs if the Chancellor sticks to the plans of delivering 2019-2020 budget surplus. According to IFS, the historical trend of official forecasting errors says that the chances of calling for in-year spending cuts and tax rises are more than one out of four.
Adding to the grim statements of IFS, economics editor for BBC, Mr. Kamal Ahmed says that people of UK will really not notice the fiscal mandates that Mr. Osborne will implement. They, according to Mr. Ahmed, will be far more interested in knowing whether they are better off or not. The only problem, according to Mr. Ahmed is that the numbers certainly look very gloomy and people feeling better off is a far cry.
For instance, a promise was made by the government that UK workers will be given a provision of larger income before income taxes are levied. However, in order to keep such a promise, the government will be needing a corpus of £8 billion. This unfortunately is unfunded.
Institute for Financial Studies says that assuming that economic conditions stay favorable, putting up a budget surplus as forecasted will require following things:
- Fuel duties and inflation are to be put up in line.
- Child benefit has to be taken away from families that belong to high income group.
- More UK households are to be pushed up to the tax slab of 45% (which is top tax slab), while still keeping the income threshold of £150,000 per year.
If the economic conditions become uncertain, which will likely happen, the Chancellor might have to take the aforementioned tough decisions. Not just that, there may be some unexpected fiscal challenges that may just show up over time. According to IFS director, Paul Johnson, actions that Mr. Osborne take when facing such challenges will determine how long he remains Chancellor.
To make the situation even further gloomy, IFS, along with Oxford Economics (the other entity responsibly for creating the Green Budget along with IFS) predicts that UK will be experiencing a sloppy growth of 2.2% for the year 2016. On the brighter side however, IFS and Oxford Economics pointed out that low prices of oil that triggered low inflation has led to strong customer spending. This is definitely a favorable economic condition in addition to good business investment environment. However, what’s coming next is certainly not easy to predict.
The Issue of Pension
After Chancellor Osborne came to office, a weird announcement came in the area of pensions. This announcement became known as the “pension freedom”. The out-of-the-blue announcement allowed people over 55 years of age to withdraw their pension money at will without having the need to purchase any fixed income product through annuity earnings.
That was good. However, things may slightly change. There are rumors floating around that in the upcoming budget of March 2016, the Chancellor is planning something that will not be considered as pension-friendly policy. It is rumored that the 25% lump sum withdrawals with no tax deductions will be totally abolished. On top of that, the annual contribution that one can make to pension fund will be pulled down to £25,000.
Complete abolishment of the system of tax relief may be on the way and the government may adopt the Isa-style system where people will be required to pay taxes up front but no taxes will be levied when withdrawals are made.
Possibility of flat tax relief rate is looming
As of now tax relief for pension contributions differ. The rules are:
- 20% relief for taxpayers falling under basic tax rates.
- 40% relief for taxpayers falling under higher tax rates.
- 45% relief for taxpayers falling under highest tax rates.
The problem with the current model is that higher the tax relief, the higher is the pressure on treasury. With current system, the treasury is taking the heat of £7 billion every single year and yes, the well-off people are benefiting far more from the system.
It may so happen that the Chancellor decides to go for a flat tax relief rate. Possible rates are 25% or 30% or 33% or at the most 35%. A flat relief rate will make things easy for the treasury but the pension industry is not very happy claiming that higher and highest rate category people will be big time losers with flat tax relief rate system while the basic tax rates individuals will be beneficiaries.
The current system has a very complex method of tax relief calculation. Here is a quick example to help you understand what happens with current system and who will win with the new proposed flat relief rate system:
Assuming that Mr. Hudson belongs to the basic tax rate slab and is eyeing for £8,000 contribution yearly. So, he should be given £10,000 pre-tax about so that after paying 20% tax, he gets to contribute £8,000. The amount he gets back as tax relief will be the same 20% he will be taxed, which is £2,000.
Similarly, if he belonged to 40% tax rate slab and wanted £6,000 in pension contribution, his pre-tax earnings should be £10,000 and his tax relief should be £4,000. So, the tax relief is far better for higher tax rate slab.
Similarly, if Mr. Hudson came from 45% tax rate slab, his tax relief will be even more. So, the current system favors higher and top relief rate slabs.
If the current system changes, who wins and who loses? This can be nicely shown using a table where the gross contribution to pension is taken as £10,000.
|Assuming that a person wants to contribute a gross amount of £10,000 towards pension||For basic rate slab||For higher rate slab||For top rate slab|
|Current system of tax relief||£2000||£4000||£4500|
|New system of flat tax relief||25% relief||£2500||£2500||£2500|
|Gain or Loss||+ £500||– £1500||– £2000|
|Gain or Loss||+ £1000||– £1000||– £1500|
|Gain or Loss||+ £1300||– £700||– £1200|
What about the Isa system?
Well, the Isa system means that pension will be considered as Individual Savings Account (Isa). As of now, people don’t need to pay any tax for their pension contributions but they will have to pay taxes when they withdraw.
The Isa-style will simple make it upside down. This means that people will have to pay tax for their contributions but will enjoy tax-free withdrawals.
This upfront taxation will allow treasury to enjoy billions of dollars of revenue from taxes that was absent in upfront tax relief. However, there are three problems:
- Isa-style will take away the 25% lump sum tax-free benefit currently in practice.
- The old style cannot be abolished totally and introduction of Isa will only make the whole system super-complex.
- With Isa-system, the only way people can reap tax benefits is after retirement. So, people will not be too interested in saving much.
So, what’s going to happen in the upcoming budget? We have to wait. There will be predictions and rumors and we will have to live through them until Chancellor Osborne finally published the budget on March 16, 2016.
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