Five mistakes that Hunt must unpick in Budget

The Chancellor must undo some of his predecessors’ errors if he wants to boost growth and productivity, writes Melissa Lawford

Jeremy Hunt’s Autumn Statement illustrated a point that many chancellors might like to politely forget. Their job is often much less about original ideas, and can be much more about grappling with the mistakes of their predecessors.

The spending plans in Kwasi Kwarteng’s September mini-budget may have been almost entirely erased, but Mr Hunt must now turn instead to curing the hangover from decades of other Treasury misdemeanours.

As Tom Clougherty, head of tax at the Centre for Policy Studies (CPS), puts it: “Mistakes have often been made, perhaps not unintentionally, but out of desperation.”

Chancellors who chase eye-catching headline policies typically come up with various small measures that escape the headlines to recoup their revenue losses elsewhere. But these can have an insidious effect.

The cumulative result is a complex, creaking tax system – which is at the heart of Britain’s problem with growth and productivity.

Here are five past Budget mistakes that Hunt should correct in today’s fiscal statement.

The stealth pension raid

“There are lots of examples of that under George Osborne – of giving with one hand and taking away with the other and storing up problems for further down the line,” says Clougherty.

One of Osborne’s key policies in 2016 was to cut the so-called lifetime allowance (LTA) – the maximum amount a person can put into their pension before they are taxed.

A surge in early retirement after the pandemic is a key problem for Hunt, as Britain struggles with a shrinking workforce. The Chancellor has signalled that he knows the shrinking LTA will be key for incentivising older workers to keep earning for longer.

When it was first introduced in 2006, the LTA was £1.5m. In 2010, it was raised to £1.8m, and was then cut several times until Osborne set it at £1m in 2016.

After 2016, the LTA rose in line with inflation. But in 2021, Rishi Sunak, who was chancellor at the time, froze it at its current level of just over £1m for five years. Since then, inflation has soared at its highest rate in 40 years.

“That is one factor that is preventing people who have retired and started using their pensions from going back into work part-time,” says Clougherty.

The LTA is a particular issue for older NHS workers, says Connor Macdonald, head of economics at the Policy Exchange. “It is a significant disincentive for them to stay in the workforce,” he says.

In turn, this has flowed into NHS staff shortages and longer waiting lists – arguably a contributing factor in the huge rise in people who are out of work because of long-term sickness.

High marginal tax rates

In 2008, the then chancellor Alistair Darling introduced the withdrawal of the tax-free personal allowance for people earning more than £100,000.

Now, for every £2 that a person’s adjusted net income is above £100,000, they lose £1 of their personal allowance. This means that people earning £125,140 or above have no personal allowance.

Those in the middle of those two salary brackets face an effective 62pc tax rate. The blow has increased because the size of the personal allowance has roughly doubled since Darling first introduced the policy.

“That makes it apply over a much wider band of income, so more people are affected by that very high marginal tax rate for longer,” says Clougherty.

This tax change disincentivises workers from trying to increase their salaries.

‘There are lots of examples of Osborne giving with one hand and taking with the other’

‘Very high marginal rates on expensive properties have caused all sorts of market distortions’

Capital allowances

Britain has a manufacturing sector in decline and a problem with business investment. A key turning point was Osborne’s changes to capital investments, says Clougherty.

One of the defining features of UK tax policy of the late 2000s and 2010s was a series of corporation tax cuts. Between 2007 and 2016, the rate fell from 30pc to 20pc.

One of the key reasons why these tax cuts did not hit revenue was because the government at the time changed how it treated capital investments.

“Under Osborne, as the headline corporation tax rate fell, the investment allowances that underpin the system were becoming much less generous, to the point that actually the sort of effective average tax rate on profits didn’t really shift much over that period at all, even though the headline rate fell,” says Clougherty

Between 2008 and 2013, the UK reduced the amount of investment in machinery and industrial buildings companies could deduct from tax bills.

“You can certainly tie that to our long-run issues with business investment, and also to the way that our economy is skewed towards financial services in the South East, versus manufacturing in the regions,” says Clougherty. This is because the system favours companies that are not capital intensive.

He adds: “If you are a business that wants to invest a lot, and how you fundamentally make money is investing in machines and factories, then you might even prefer a slightly higher rate of corporation tax if it came with more generous investment allowances.

“That’s a chronic problem in the economy.”

Stamp duty

In 2014, Osborne overhauled the stamp duty system. He transformed it from a slab system of rates, across the entire value of a property, to a marginal rate system. Buyers at the lower end of the property ladder paid much less tax.

“That in itself was an extremely positive reform that removed some of the market distortions,” says Clougherty. But there was a kicker.

“That was accompanied by introducing very high marginal rates on expensive properties, and that has caused all sorts of property market distortions ever since,” he adds.

On the value of a property from £925,000 to £1.5m, the stamp duty tax rate in England is 10pc. Above £1.5m, it is 12pc. This has a hugely disproportionate impact on home purchases in London and the South East, where high house prices mean family homes can fall into these brackets.

Buy-to-let tax crackdown

Britain is in the midst of a rental crisis. Rents are rising at the fastest pace on record and there is an extreme shortage of supply relative to demand. Yet landlords are selling up in droves. About 35,000 more rental properties were sold than bought in 2022, according to analysis by Hamptons estate agents.

Another Osborne tax change has been key. In 2015, Osborne announced that tax relief on buy-to-let mortgages would be phased out. Previously, landlords who own properties in their own name could offset all of their mortgage interest costs against their tax bill.

Since April 2020, they have only been able to deduct 20pc of their interest costs.

This means that they must continue to pay tax even if they are making a loss.