The good that tax breaks do

Few Budgets have provoked as much dread and foreboding as chancellor Rachel Reeves’ first one. Preceded by stern pronouncements on the perilous state of the UK’s finances, and a refusal to discuss what changes are being planned, next month’s Budget is scaring a lot of people, including the chief executive of the London Stock Exchange. 

Public finances are tight. The national debt has topped 100 per cent of GDP; government borrowing has jumped unexpectedly and is predicted to keep rising. There is, says the EY Item Club, no wiggle room. Yet the easiest and least harmful way to raise billions – a rise in income tax – has bafflingly been ruled out, and the hatchet appears to be hanging over tax breaks designed to incentivise sensible behaviour and deliver growth. Pantheon Macroeconomics thinks the chancellor will aim for tax hikes of £10bn a year, focusing on capital gains tax (CGT), inheritance tax (IHT) and pensions tax relief. 

Some of the options available to Reeves – subjecting pension pots to IHT, capping the tax-free lump sum and Isas, charging CGT to assets passed on at death, for example – should not cause harm to the economy or people’s future financial security. Others would inflict a lasting blow to families' ability to pass wealth to their children, for example through the axing of the residence nil-rate band and applying strict limits to lifetime gifting.

But there are at least two sets of tax reliefs – those on pensions and business assets – where an overhaul would risk causing significant damage to economic growth and private sector pension pots. Yet, there are many urging the chancellor on, the Institute for Fiscal Studies (IFS) and the Fabian Society among them.

“Every pound foregone [in pension tax relief],” says Andrew Harrop at the Fabian Society, “translates into a pound less of public spending.”

Cutting pension tax relief to prevent high earners from receiving relief at their marginal rate would deny individuals in defined-contribution (DC) pensions the chance to boost their pots as their earnings increase. Accruing a reasonable pension pot would become instantly more challenging and require many more years of contributions. And higher-rate taxpayers’ pension savings would be taxed twice, on the way in and the way out. The IFS also recommends making employers pay National Insurance on their contributions to employee pension schemes, a move it says could raise £17bn a year. It seems highly likely that this would result in employers reducing their pension fund contributions by billions in return. 

The brunt of these measures would fall on private sector DC pension pots, which do not come with defined-benefit schemes’ comforting guarantees. Billions of pounds would be sucked from private sector pensions for day to day government spending.

Business relief is another tax likely to be on the chancellor’s menu of options. Concern that it might be removed or curbed is provoking consternation in the City. Doing this would, as Dame Julia Hoggett has pointed out in a letter to the Treasury, risk destroying Aim. 

Aim is a crucial part of the financial ecosystem. Its companies are, says Charles Hall at Peel Hunt, “fundamentally important to business creation, scale-up funding, job creation and economic growth in the UK”. 

The ability to raise capital from investors is essential to companies’ success, making incentives necessary. Otherwise why would anyone risk their capital? Were business relief removed, Hall believes Aim share prices could fall by up to 30 per cent and investors, which includes company employees, would lose up to £20bn of value. He adds there would be little appetite for funding Aim companies in future.

Grant Thornton highlights how in 2023 Aim added gross value of £68bn and 778,000 jobs to the UK economy, generating over £5.4bn in tax, not including VAT, income or dividend tax. 

In the face of this uproar, it seems unlikely that business relief would be tampered with. But some in academia and the Labour party refuse to see it as anything other than a rich person’s tax break. Academics are aghast that "capital is moved into particular investments not because they are productive but because they offer a tax break" but this willfully ignores the need to incentivise investment into growth companies.

Imagine how taken aback one Aim CEO was when in response to a request to his new Labour MP that business relief be protected, the MP sent him a link to the Octopus Aim Isa website, which outlined how investors could “pass on more wealth”. The MP, he said, could not see this was a sales pitch, not a reason to ditch business relief. 

Politicians have a duty to act in the country’s best interests. That means assessing tax breaks with an open mind and in the round, not judging them on one single 'unpalatable' aspect.

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