14 May 2010 | Economy

Deficit Presents a Taxing Challenge 

The post-ballot bargaining and debating are finally over. In the wake of the inconclusive 2010 General Election, it took almost a week of intense meetings, demands and concessions before the new government was formed. Now we know that the United Kingdom will be governed by a Conservative-Liberal Democrat coalition.
  
The first big task for this alliance will fall to the new Chancellor of the Exchequer, George Osborne, who must make an emergency Budget speech within 50 days. His words will add meat to the bones laid out in the agreement signed by the two parties on May 12.

The main objective of his announcement will be to drive deficit reduction – cutting the country’s indebtedness. And that could have implications for investors who have so far had a muted reaction to the election result. Indeed, events in the Eurozone have been of greater significance for investment markets than a change of government in the UK.  

Osborne’s Budget will feature a proposal to deliver the Conservatives’ aim of achieving £6 billion in spending cuts to non-frontline services over the current financial year. There will also be details of measures designed to increase tax revenues.

Initially, Inheritance Tax cuts and the Conservative plan to offer tax breaks to married couples will be treated as lower priorities. However, plans will be implemented to reduce Child Trust Fund payments and tax credits for higher earners. These moves are consistent with the coalition’s declared intention to favour middle and lower income groups.

Personal allowances for income tax will be increased. This will be funded with the money from a rise in Employee National Insurance payments and revenues generated by an increase in Capital Gains Tax (CGT) rates for non-business assets.

This latter step will see the rate of CGT rise from its current level of 18% to a figure approaching 40%. It is not yet clear whether the changes would allow for implementation of the Liberal Democrat proposal to reduce the annual CGT allowance from £10,100 to £1,000. Some tax advisers suggest that this will spark a rush by private investors to sell shares and second homes in order to lock in gains at current levels. 

Over the longer term, the parties want to impose a banking levy and appoint an independent commission that will consider the break up of big banks. Pension reforms are also on the agenda, with the parties agreeing to raise the state pension age to 66 and remove the rule that enforces the purchase of an annuity at 75.

Some things have been ruled out, however. For example, the Conservatives have forced the Liberal Democrats to agree that they will not propose joining the euro – hardly unpopular given the single currency’s current travails.    

As they announced the broad terms of their coalition, Prime Minister, David Cameron, and his deputy, Nick Clegg, were pictured exchanging banter outside 10 Downing Street. On the face of it, they have reached agreement on how to govern the country. Nevertheless, the extent of the consensus between the two will only become clear over the coming months.

And, it is worth remembering that this is a marriage of convenience. It remains a possibility that – like many relationships in the UK – it may not last until its fifth anniversary.
 

Author: Colin Renton
Colin Renton is an investment writer in the Institutional Clients Department of Baillie Gifford. He joined the firm in May 2007 having spent the previous seven years in similar roles with two other investment managers. Colin has more than 20 years experience in financial services and holds professional qualifications from the Chartered Institute of Bankers in Scotland and the Chartered Insurance Institute.