Covid-19 will have a profound impact on the UK’s public finances and could mean the Government has to consider tax increases in the future.
The Covid-19 lockdown has resulted in a massive curtailment of economic activity, with the Office for Budgetary Responsibility (OBR) estimating a 35% drop in productivity in Q2 2020 and a 13% fall in annual GDP in 2020.
That exceeds the fall caused by either of the world wars or the financial crisis.
The chart below shows the expected fall in output from key industries based on a lockdown lasting around 3 months. Key sectors like construction which contributes 6.1% to the UK economy could suffer a 70% fall.
The OBR estimate the impact on jobs will see unemployment increase to 10% in the second quarter, with 2.1 million more people unemployed (up to a total of 3.4 million).
As a result the Treasury will receive far less than predicted in taxes linked to jobs and commerce. Taxes such as VAT and Income Tax depend on economic activity and are key revenue generators for the government.
At the same time the country will be spending far more than expected due to the new rescue packages aimed at protecting jobs and business, as well as the increase in claims for welfare support.
Overall, the OBR predicts tax receipts will be 15% lower in 2020-21 than assumed in the Budget. Spending will be 9% higher than forecast.
It means borrowing is projected to rise to £273bn in 2020-21, the highest deficit since WWII.
At some point the Government will need to develop a long-term strategy to repair public finances. Although initially the UK will borrow more to meet the shortfall, in the longer-term government will need to look at which parts of society it feels are most able to carry the burden of higher taxes or lower public spending.
The Conservatives pledged in their election manifesto not raise income tax, national insurance contributions or VAT. In practice, that may be difficult to adhere to and the electorate could grant them some licence given the unexpected nature of this crisis. The Chancellor has already hinted that the rate of National Insurance tax for self-employed workers may increase.
Nonetheless, the Government may need to consider raising taxes in other areas. This could include higher taxes on wealth and assets, which could have a significant impact on personal financial plans.
Newspapers like the FT and the New York Times are already predicting that wealth taxes will be considered, and certain academics are also arguing in favour of higher taxes on capital.
It will be some time before this crisis is over and the Government will be reluctant to choke a recovery by raising taxes too quickly. But we anticipate that over the course of this Parliament the Government will set out plans for tax rises aimed at repairing public finances.
How those tax changes are implemented and who they affect could have a marked impact on our financial planning advice to you.