A pre-Budget bombshell

By Annunziata Rees-Mogg Dec 13, 2005

The pre-budget report came out on Monday and contained a number of surprises. Now the dust has settled, we look at what Gordon Brown’s speech really told us.

Brown’s running on empty

After eight years, the Iron Chancellor is running out of both ideas and money, says Neil Collins in the Evening Standard. Brown’s pre-Budget “rant” was a parody of his earlier attempts to sound good. This time, he claimed that his task was to “meet and master the global economic challenge”.

What can he possibly mean? He might be able to meet all sorts of challenges, but master them? Says Collins: “Oh come on”.

The fact is that Brown is finding it increasingly hard to stretch the facts even partially to fit his rhetoric. That’s why he endlessly bangs on “about relative trivia, while failing to find the space for important measures”. But if you ignore all the former, thefacts are clear. The chancellor has been spending more than he has been getting in – which in turn means that not only are we in the red by £37bn right now, but it is impossible to see how the situation can be turned around.

The UK economy isn’t growing

Brown knows his glory days are over and that is why he fairly sprinted through the part of his speech telling us his previous growth forecasts had been far too optimistic. He now tells us that economic growth this year will come in at a feeble 1.75%. That’s more or less what everyone else thought already, but given that he was claiming growth of up to 3.5% in the spring, and 2.5% in the summer, it is a “spectacular climb-down,” says Tom Stevenson in The Daily Telegraph. And, of course, he has made such a habit of “pretending the economy is growing faster than it actually is” that the downgrade “came as a bit of a shock”. Now he is going to need a lot of luck if he’s going to meet his golden rule.

The golden rule is a sham

Brown’s golden rule is that the budget should balance over the course of an economic cycle. That seems straight forward enough. But it isn’t. Why? Because Brown gets to decide when the cycle starts and when it ends.

Back in July, he gave himself a bit of leeway by changing the beginning date of the current economic cycle. Now, however, he has excelled himself by shifting the end date out, too. Now the cycle will, says Brown, not end in 2007, but in 2009, by which time, of course, he fully expects the issue of whether or not the budget balances to be someone else’s problem.

This is absurd, says Robert Chote, the head of the IFS. The so-called cycle is now 12 years long, that is “less a cycle than a stretch limo”. The goalposts have been moved so far “that they are barely still on the pitch”. And even with this sleight of hand in place, Brown will still only have a surplus of 0.1% – which is “an extremely narrow margin of error”, according to Merrill Lynch. And guess what that means for taxes?

Tax is on the way up

Brown didn’t announce much in the way of obvious new taxes in this report, but that doesn’t mean they weren’t there. “So what was the chancellor hoping that you would miss?” asks Ruth Lea in The Times. His odd attitude to oil, for starters. He blames it for the UK’s low growth, despite the fact that we are still self-sufficient in oil, and the many countries that aren’t still seem to be growing perfectly well. And if he thinks oil prices are too high, why is he introducing new taxes that will just make things worse? He has now effectively bumped the corporation tax that UK oil producers have to pay up to 50% (the normal rate is 30%), something that will conveniently provide an extra £2bn for his coffers.

This is a “swingeing tax increase on the oil giants”, says Benedict Brogan in the Daily Mail. And it also isn’t going to hit the profits of the oil majors, Shell and BP, much as they barely operate in the North Sea anymore. Instead, it will hit the smaller firms trying to explore for what little oil there is remaining in our North Sea fields, and just as we are running low on both oil and gas. How does that help anyone (except for the chancellor – in the very short term, that is)?

Brown also kept going with his favoured policy of fiscal drag (not raising allowable limits in line with wage inflation). The threshold for income tax went up – but in line with prices, not with earnings – which means that more people are going to be caught as wages are currently rising faster than inflation.

There was also no further change on the inheritance tax threshold, and he took a swipe at tax-minimising trusts, based in the UK and abroad, and added VAT to games machines. While he has promised to leave petrol tax where it is, the ‘red diesel’ went up (see column, right). Still, all this is small beer next to the tax rises that are probably on the way if Brown keeps spending and the UK keeps growing at its current below-trend rate. “Sooner or later,” says Roger Bootle, economic advisor to Deloitte in The Guardian, Brown’s going to have to give up the pretence of being a Robin Hood figure who wants no more than to help pensioners and the deprived young and instead “play King John and raise taxes more widely if he is going to put the public finances back on track”.

Hurting business hurts us all

Some see most of Brown’s moves as more or less “victimless crimes” in that they hit only “property owners, accountants’ clients and oil giants”, says Philip Thornton in The Independent. But this simply isn’t the case. As Martin Wolf points out in the FT, “the chancellor did not tax ‘business’. He is taxing the public as a whole.” Business organises almost all the economic activities on which everyone depends. What businesses decide to do – based on the environment in which they operate – affects everyone, from workers, shareholders and lenders to customers. From the Chancellor’s point of view, “companies are wonderful tax-raising machines”, but “behind the corporate veil are only people” paying other people’s wages, and they all mind being taxed.

Sipps aren’t any fun anymore

Brown tried to distract us from the bad news by promising that the poor would all be better off. Pensioners would get free insulation, teenagers would get gap years, the family tax-credit system would be shaken up and improved. However, this is not what this pre-Budget report will be remembered for, says Anne Ashworth in The Times. Instead, it will be known as the one in which he announced that people will not be able to use their personal pensions to invest in residential property or in ‘exotic investments’ (wine and the like).

This has maddened the financial services industry, which has spent much time and money preparing to help people do just that (as it was widely assumed they would be able to from April next year). This is the most enormous U-turn, says Jerome Melcer of BDO Stoy Hayward Investment Management, in The Times. What a lot of money and time wasted.

But according to The Daily Telegraph, Brown’s move is more than just irritating, it throws doubt on his basic levels of competence. Anyone who has made arrangements for their pension based on what Brown said he was going to allow them to do has been “left high and dry”, said an editorial in the paper. “What a scandalous way to run an economy. If Mr Brown cannot be trusted as a chancellor, why should anybody put faith in him as a prime minister?” The answer, unless he comes up with a solution to the UK’s budget woes relatively soon, is that they very probably won’t.

How the report will affect your pension

Pensions have grabbed all the headlines. Gordon Brown “shocked those saving for their retirement… by announcing that investors would not be able to put residential property into a pension after all”, says Justin Harper in the Daily Mail. Self-invested personal pensions (Sipps) were due to become more flexible from April 2006, meaning that you were going to be able to put anything from wine or racehorses to holiday homes into your pension – claiming up to 40% tax relief in the process. However, Brown performed “one of the biggest U-turns in his time as Chancellor” and declared none of these “exotic” investments will be Sipp-eligible after all. 

In anticipation of the changes, a vast industry has sprung up to cater for the new interest in Sipps over the last few years. Overall, “several hundred million pounds” have probably been spent so far, says Tom McPhail, head of pensions at Hargreaves Lansdown, in The Independent. That’s all wasted now.

But just as irritated as the financial services industry – seeing all those potential commissions vanish into thin air – will be people who have bought properties with the intention of transferring them into their Sipp in April. Now they are stuck with properties they wouldn’t have bought otherwise and won’t get any tax relief on. Presumably, they’ll all now try to sell, making the glut of buy-to-let properties on the market even worse.

The chancellor, in his largesse, did make one concession to those who have put deposits on new-build houses that have not yet been built. They can still get tax relief, but only if they sell the property before it is finished (ie, before it becomes residential – under the existing provisions, Sipps are allowed to invest in commercial property).

However, this also has its drawbacks, as not only would it force people into quick sales (no doubt at knock-down prices), but it would also mean that the money would then be trapped in a Sipp – if you take it out you will lose the tax relief, if you keep it in you can’t buy any more property. And even more irritating for those caught in this trap, the Sipp business is unregulated, so they can’t look for any compensation.

This could be very bad news, says Richard Proctor, tax partner at Grant Thornton in the FT. “Because people were turned off by the stockmarket, it was a way of getting them back into pensions. This U-turn could nip a potential revival in pensions in the bud.”

What it means for your tax bills (they’re up)

The chancellor wouldn’t know how to produce a Budget, or pre-Budget, without increasing the cost to taxpayers. It was hardly a surprise that fuel taxes remained capped at current levels – Brown must still remember the fuel protests in 2000. However, he did manage to slip in a rise of 1.22p per litre onto the duty of ‘red diesel’, which is used for off-road vehicles, such as tractors. And it isn’t just farmers who have lost out. Zero-rate corporation tax, as well as higher tax on money paid out of small companies (say to  directors as dividends), both went as the chancellor thought the existing system encouraged tax avoidance.

There was bad news for individuals trying to keep their bills down too. Foreign trusts set up to convert potentially taxable wealth into an exempt interest abroad will lose their exemption from inheritance tax, unless they were bought before Monday, and UK-based trust regulations have been tightened, making it  harder to shelter assets within a trust to avoid inheritance tax.

If you have any land that you want to build on, then Brown has his eye on you too. In the past, if land was granted planning permission, which causes the price to rocket, you had to pay only the usual capital gains tax. Now you’re going to have to pay a supplement too. The figure hasn’t been set, but is expected to take another 20% of your gains off you. Gamblers are also getting hit – there is now to be VAT payable on gaming machines. On the plus side, the tax credits on offer to the film industry have gone up and Brown has also introduced a lower VAT rate of 5% (rather then 17.5%) on the installation of wood-fuelled burners. Still, that won’t do you any good if you live in London, where you aren’t allowed to burn wood.

What it means for property and investing

One of the biggest changes Gordon Brown announced on Monday is the creation of real estate investment trusts (REITs) in the UK for the first time. These are essentially funds that invest in property – meaning that those wishing to place their money in the property market now have much easier access.

Another boost to housing investment came in the form of support for first-time buyers. Three building societies and four construction companies are going into partnership with the Government to get them on the property ladder. The buyers will be offered a ‘shared equity scheme’ in which they will only have to provide 75% of the cost of the house, with the remaining 25% coming from the Government and companies. The purchasers would then be able to keep 75% of any profits if they decided to sell (assuming, of course, that there were any profits – this is no longer a given).

The market wasn’t too keen on the pre-Budget report: following the chancellor’s statement to the House of Commons, the London markets fell, thanks partially to the effect of his plans on small and medium-sized oil companies. With the supplementary oil and gas corporation tax doubling from 10% (where it was set when it was introduced in 2002) to 20% it brings the total corporate tax payable to 50% for North Sea operations.

“This tax rise could devastate the North Sea if it is not rescinded,” said an oil company official to the FT. And it will hit the smaller companies worst. Canadian-listed Nexen, which has wells in the North Sea, has already announced that “the deterioration of fiscal terms in the UK and the frequency of these changes could impact our future investment decisions”. Some of the older wells – taxed more heavily than new ones – could now face tax bills of up to 75%, putting them at risk of closure. Analysts also warn that companies looking to invest in the area are now less likely to.

What they’re saying about Brown’s Budget

“The first Government of any party to achieve eight years of uninterrupted growth since 1805.”
Gordon Brown in the pre-Budget speech

“There is one similarity of note: then, as now, the chancellor of the day faced a Budget shortfall. In 1806, income tax doubled. What will Mr Brown have to say about that next year?” Julian Glover in The Guardian

“This is a chancellor who is now holding Britain back. I don’t remember him telling the electorate before the general election that the economy was facing a tough and challenging year. What he told the country at the time of the last election was not true.’’ George Osborne, shadow chancellor

“Monies paid in taxes aren’t available for investment in our operations.”
BP

“Sipps; now there’s another fine mess.”
Jeremy Warner in The Independent

“We are condemning the chancellor’s business plans as we believe they will help to make Britain the poor man of Europe. Only by creating a low-tax environment can businesses flourish.”
Forum of Private Business

“That the Treasury now expects growth to remain weak in 2006 suggests that something longer lasting and more worrying is at work.”
Gavin Redknap, economist, Standard Chartered

Published in Economics | More articles by Annunziata Rees-Mogg

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