TheCityUK's analysis of Budget 2016

In the last Budget before the UK’s referendum on EU membership, Chancellor George Osborne today presented an image of the UK economy performing well relative to other advanced economies, despite slowing domestic and global growth and increasing global economic risk. Real GDP growth in the UK was 0.5% in Q4 2015, broadly unchanged from the growth rates in the first three quarters of that year.

However, both global and domestic sentiment is weak, and has worsened since then; UK business investment fell by more than 2% quarter on quarter in October-December, and consumer sentiment wobbled in the latest reading (from February). Acknowledging the economic headwinds, the OBR today sharply revised down its forecast for GDP growth in 2016 to 2%, from 2.4% in its November 2015 forecast. Growth is forecast to revert to 2.2% (the 2015 rate) in 2017.

The Chancellor noted that the OBR’s economic forecasts are predicated on UK’s continued membership of the EU[1]. Although it is not possible to make a definitive assessment of the overall economic costs and benefits for the UK of EU membership, TheCityUK’s analysis shows that EU membership has been positive for the UK economy, and so Brexit would risk adding to the economic challenges already posed by slowing domestic and global growth.

FISCAL CONSOLIDATION

Despite the worse-than-anticipated economic outlook, the Chancellor’s economic policy priority remains the transition from budget deficit to budget surplus and a progressive decline in the debt-to-GDP ratio. TheCityUK has previously noted that the UK’s budget deficit is structural, not cyclical, making its elimination a challenging policy target[2]. The challenge is even more acute under conditions of subdued economic growth and downside economic risks, since downward revisions to real growth reduce tax revenue projections, which make deficit reduction more difficult. Slower-than-expected inflation—now forecast at 0.7% in 2016 (down from a previous forecast of 1%, and still far below the Bank of England’s target of 2%)—also has an impact, since lower-than-expected levels of nominal GDP mean that the debt-to-GDP figures automatically worsen, all else being equal. Indeed, today’s Budget acknowledged that the commitment to progressively reduce the debt-to-GDP ratio has now proven impossible: as a proportion of GDP, government debt is now estimated at 83.7% in 2015/16, up from 83.3% in 2014/15 and higher than the 82.5% forecast in November. It is forecast to fall again to 82.6% in 2016/17, though further downward revisions to growth and/or inflation would again jeopardise this target.

However, with a view to trying to ensure that the public finances are in surplus by 2019/20, the Budget emphasised continued—indeed, deeper—fiscal consolidation. This deepening was reflected in the announcement of an additional £3.5bn in budget cuts.

TAXES

Despite the policy intention to move the public finances into surplus, the Budget included several personal-tax measures that will make the attainment of a budget surplus more difficult by reducing revenue. In summary, with effect from April 2017:

  • the personal-allowance threshold will be raised to £11,500 (higher than the £11,000 announced last year); and
  • the threshold at which the 40% rate of income tax is applied will be raised to £45,000 (higher than the £43,300 announced last year)


TheCityUK welcomes these changes as they make the personal income tax regime more competitive and gives the individuals affected greater control over their personal finances.

Not all the emphasis on tax policy was on rate reduction, however. The planned spending cuts will be complemented, as in the July 2015 Budget, by a focus on combatting tax avoidance, with today’s Budget promising to raise £12bn over the course of this parliament from measures to stop tax evasion and minimise tax avoidance. TheCityUK has consistently put forward the view that firms must pay the tax for which they are liable, and we believe that the implementation of measures to clamp down on tax evasion and avoidance will reinforce the message that no companies are above the law.

BUSINESS TAXES

The surprise move to reduce the rate of corporation tax to 17% by April 2020—even lower than the 18% promised in last year’s Budget—will further increase the gap between the UK’s basic corporate tax rate and that of other G20 countries (assuming that other large economies do not make similar phased reductions; the UK’s current rate of 20% is equal to the rate imposed by Russia, Saudi Arabia and Turkey, and half the 40% rate levied in the US[3]).

In its Representation to HM Treasury ahead of this Budget[4], TheCityUK had called for the Government to focus tax-reform efforts on (among other areas) business rates, since the existing system of rates includes significant variation by sector and was thus ripe for restructuring and streamlining. We therefore welcome the Chancellor’s promise to streamline the tax regime for small businesses—for example, by “modernis[ing] the administration of business rates”—as this is very much in line with our recommendation that any reforms should concentrate on policy simplification.

This focus on tax-policy simplification must apply to all firms, not just small businesses, and so we welcome the Government’s promise to “continue to simplify and modernise the tax system”. This should enhance the competitiveness of the UK’s business environment by bolstering policy stability, which we repeatedly hear our member firms describe as being a critical part of a strong operating environment. Our Budget Representation had noted that the recent rapid pace of change in the tax-regulation sphere means that the volume of regulation and compliance requirements for businesses are now are critical aspect of the UK’s competitiveness as an international financial and related professional services hub.

The move to permanently double small-business rate relief (to 100% from 50%) and to increase the maximum threshold for tapered relief (to a rateable value of £12,000-15,000, up from the current £6,000) addresses TheCityUK’s call in 2015 to implement policies that will reduce the tax burden on small businesses, which are a critical driver of employment growth in the UK.

INFRASTRUCTURE

The Chancellor’s commitment to spending more on infrastructure projects right across the UK – including the development of plans for Crossrail 2 in London and high-speed rail in the north of England–is essential to ensuring future job creation and spurring longer-term economic growth. Similarly, the investment in Trans-Pennine, East-West links sets a hopeful precedent for the new National Infrastructure Commission’s plan to review the strategic infrastructure associated with the high-growth cities found in the Cambridge-Milton Keynes-Oxford corridor.

As noted in our Budget representation, commitment to providing investors and consumers with certainty, increasing the Government’s own capacity to deliver projects and finding effective ways to attract and maintain new sources of finance are all essential to ensure a strong infrastructure pipeline. The creation of the National Infrastructure Commission and the acceptance of its three first recommendations shows that this part of the system is off to a positive start. We look forward to examining the National Infrastructure Delivery Plan when it is published.

Spending to draw up plans for high-speed rail in the north is a positive step in helping to move forward the agenda of the Northern Powerhouse. With over 400,000 people employed in financial and related professional services across the north of England, and cities such as Leeds, Liverpool and Manchester being major regional industry centres, we urge swift progress on modernising the rail route right through from Liverpool to Leeds line. This will not only boost connectivity between these major northern cities, but will also help better promote the Northern Powerhouse as a regional hub with global ambitions.

Energy
The National Infrastructure Commission agreed with TheCityUK that there is a pressing need to ensure the security of the UK’s gas supplies. Gas will continue to have a major role in supplying heat and electricity to homes and businesses. As renewable power generation grows the intermittency of power generation will go up and increase the role of gas as the back-up[5]. The plan to invest in additional interconnectors with other European countries, with the UK becoming a world leader in electricity storage systems, is an example of a long-term investment that will help the UK to cope with the forecast energy shortages brought about by planned decommissionings.

Rail
Crossrail 2 is an investment of national significance, because of its impact beyond Greater London. For Crossrail 2, sufficient funds should be released in order for Transport for London and the Department for Transport to submit a revised business case for Crossrail 2 by March 2017, with the aim to introduce a hybrid bill by autumn 2019.

The Shaw Report on Network Rail provides possibilities for future finance. For example the sale of concessions or leasing of Network Rail-owned stations to private bodies able to invest and refurbish them for the benefit of the travelling public could, if carried out properly, bring many benefits – creating areas of urban and countryside regeneration and innovation.

There is a wider question concerning Network Rail that needs to be addressed as part of the process. A nexus of cross-subsidies and payments inside the UK’s rail network means that there is very little real understanding of the profitability and demands placed on the individual parts of system. There is no appetite or demand for privatisation, handing whole entities over to the private sector. However, greater transparency would enable the public to assess the value of the routes, provide justifications for the social use of the routes and provide a baseline for assessing future investment in the system and where private sector funding or participation could be of benefit to travellers and government alike.

RETAIL FINANCE

In a move targeting the roughly  1 million families[6] in receipt of Universal Credit or Working Tax Credits, the Government this week announced its new “Help to Save” scheme intended to encourage low-income individuals to save by offering a top-up of up to £1,200 over four years. In today’s Budget, the Chancellor referred to this scheme, but also introduced a new “Lifetime ISA” for people under the age of 40. TheCityUK published research on the day before the Budget emphasising the importance of retail financial services in helping individuals plan for their financial futures[7]. The new report notes that “a core role of financial and related professional services is to help meet the aspirations of individuals and help them prepare financially for the future”; the industry will therefore have an important role to play in ensuring that the new scheme meets the objectives of both the Government and the participants, and we welcome the Chancellor’s assertion that Government will consult with the industry on the details of the implementation of the new savings scheme.

[1] The OBR notes: “We have made no assessment of the potential long-term impact of ‘Brexit’ on the economy and the public finances, as Parliament requires us to base our forecasts on current Government policy and not to consider alternatives."
[2] TheCityUK Responds to the July Budget, TheCityUK, July 2015
[3] Based on KPMG research cited in the Budget
[4] TheCityUK 2016 Budget representation, TheCityUK, February 2016
[5] Smart Power, National Infrastructure Commission, March 2016
[6] TheCityUK calculations based on Office for National Statistics data
[7] Retail Financial Services: bringing real benefits to Europe’s customers, TheCityUK, March 2016