Budget Predictions: What’s in and what’s out as Rachel Reeves finalises Budget

The Chancellor, Rachel Reeves, is in the home stretch before Wednesday’s Budget. But it may not be the finishing line she is hoping for. Speculation has been in overdrive ahead of the Budget - it's been going on for months now. Yet we may start to see the outline of what's coming, with a couple of days before the event. 

A couple of weeks ago our Budget scenarios looked something like this -

1. Tax hikes + no major spending increase = more headroom, contractionary but not inflationary = gilt markets happy, BoE cuts more to stimulate growth...this means yields fall, sterling is steady.. Risk is rebellion leading to political uncertainty, which spikes bond yields on threat of left-leaning takeover.

2. Go bigger on tax hikes, credible effort to cut spending = enables BoE to cut even more...growth weaker but market happy that yields falling faster. Risk as above but more elevated. Sterling is hit. Perhaps the best way to escape the fiscal doom loop by lowering gilt yields and buying a lot of extra headroom.

3. Go small on tax hikes – pushes up yields and risks credibility (need to come back for more), headroom too small...fiscal risk premium for gilts shows up in sharply weaker sterling.

4. Do wrong tax hikes, increase spending too much (eg Living Wage, two-child benefit cap) – too inflationary, BoE scope for cuts reduced.

With a blanket income tax hike now seemingly off the table, we are left with a combination of 3 + 4.

This means an untidy, inflationary, backdated ‘smorgasbord’ of tax hikes. I think this makes for a greater chance of a negative gilt market reaction.

Plans to end the two-child benefit cap are noteworthy if it is indeed included in the Budget. This comes at a cost of £3bn. Not only does it suggest Reeves is bending to pressure from members of her own party, it will raise welfare spending, in the short term at least. While this will be tied up with a promise to crack down on benefit fraud and tackle welfare reform, banking on the market swallowing it this seems risky. Given the government has consistently failed to push through any reforms or cuts, to assume it can impose restraint in 2029/30 is scarcely believable. Reeves is relying on the market believing that somehow the Labour machine can impose spending restraint when all the evidence suggests the opposite is the case. Moreover, some of the likely tax-raising moves could take time to enact. Markets will consider just how credible each of the various measures are and if they cumulatively fall short then a reaction in gilt markets and sterling is likely.

Here’s the latest on what I think will be included in the Budget this week. 

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Income tax

No sweeping increase to the basic or higher rates, but thresholds will be frozen for longer. Extending the freeze by another two years to 2030 would raise around £8bn in additional revenue for the Treasury. It is one of the few big tax-raising levers the Chancellor has available to her.

Savings & Investment

Changes to Capital Gains Tax seem likely. The government raised Capital Gains Tax at the last Budget, increasing the lower level from 10% to 18% and the higher rate from 20% to 24%. Another option is to reduce the annual exemption allowance – although this has already been slashed in recent years from £12,300 to just £3,000.

Dividends: The tax-free dividend allowance is £500 per year – down from £5,000 a few years ago. Lowering this level may not be practical, but not unimaginable. More easily, the current marginal dividend rate of tax, ranging from 8.75% to 39.35% based on your earnings, could be brought in line with income tax.

In a bid to boost investing in equities, a cut in the annual cash ISA allowance from £20,000 to £12,000 is being looked at.

Pensions

The Treasury has ruled out scrapping the 25% tax-free lump sum, and it looks less likely that pension tax relief will be messed with, although I still believe there is a low political cost to reducing relief on pension contributions for higher rate taxpayers and therefore remains on the table. What is looking increasingly certain is that the Chancellor will cap salary sacrifice perks, in a move that could raise as much as £4bn. It’s thought Reeves could impose a £2,000 cap on the amount people can put into their pensions without paying National Insurance. This may take some time before delivering revenues.

Property & Wealth

A new tax on higher value homes is the most popular bet. About 2.4 million properties in council tax bands F, G and H will be revalued, with a surcharge imposed on the most valuable – expected to be the most expensive 100,000 and impact homes worth more than £2mn. While property has long been considered a useful nut to crack, this could some time to implement. There is also further chatter about a straight mansion tax on properties worth over £2mn of 1%.

On the plus side, the Chancellor may get the jump on a Conservative pledge to scrap stamp duty, replacing it with a tax on sellers. This move could be a considerable boost to the housing market and to housebuilders.
A straight-up wealth tax and exit taxes previously mooted seem to be off the table but could still be used.

Inheritance

The Chancellor could introduce a lifetime cap on gifts, which currently are unlimited. Tapering relief rates – the discount applied by living at least three years after gifting, could also be altered. The 7-year rule could be stretched to 10.

Exemption from IHT may change - the freeze on the nil-rate band, which has been set at £325,000 since 2009, is due to expire in April 2028. This seems a likely candidate for extension. The residence nil-rate band – currently set at £175,000 – could be removed.

Motorists

The Chancellor is likely to impose a new pay-per-mile tax on electric vehicle drivers. Fuel duty, which has been frozen for 15 years, could also be increased. A temporary 5p cut in the duty seems set to end. Reeves is also likely to extend an electric vehicle grant for another year, at a cost of £1.5bn.

Business & other taxes

A gambling tax seems likely to hit bookies, whilst banks are back in the firing line for a potential hike to the amount they pay on top of the standard rate of corporation tax. The Chancellor may also introduce a ‘taxi tax’, adding VAT to all private hire journeys, as well as an ‘Airbnb tax’, a nightly tourism tax introduced already in Scotland and Wales. There could be hikes to alcohol duty - one left-leaning think tank suggested booze is a productivity issue. And a Cycle to Work scheme that gives high earners massive tax breaks to buy fancy road bikes will be curtailed.