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By Rhian Nicholson

Monday, March 22, 2010.

The day of reckoning is edging closer, with tax hikes and spending cuts seemingly inevitable, while wealthier families are likely to bear the brunt of the cost under Labour's plans.

However, it's going to be a difficult juggling act with the election just around the corner.

Furthermore, the European Commission recently said that the government's plans for reducing the budget deficit will allow it to cut its deficit in line with EU rules by a deadline of 2015. So just what can chancellor Alistair Darling do to get its finances in order and reduce the £178 billion budget deficit while keeping the voters on side?

Richard Mannion, national tax director at Smith & Williamson, says: "The big earners for the government are income tax, national insurance and VAT. Together, these taxes typically represent around 75% of the government's annual revenue. So unless there are tax rises in one or more of these areas in the not too distant future, the government will have very little chance of balancing the books."

However, many financial professionals are expecting a "phoney Budget" with any hard hitting, significant tax raising measures deferred until the second 2010 Budget.

Stephen Herring, BDO Stoy Hayward's senior tax partner, concluded: "I fear that the March 2010 Budget is bound to be more about 'Punch 'n' Judy' politics rather than important fiscal reforms. Sadly, it is almost unavoidable that taxes will rise after the election, in addition to cuts in government spending, irrespective of the outcome."


February's public finances figures gave the chancellor a welcome boost with public sector net borrowing coming in a lower than expected £12.4 billion while January's figure was revised down from £4.3 billion to £43 million.

The figures leave a total deficit for the first 11 months of the year of £132 billion, suggesting that Darling may now hit or even undershoot his full-year forecast on this measure of £170 billion.

Economist Jonathan Loynes of Capital Economics says: "As such, he now looks likely to have a little wriggle room in the Budget to either cut borrowing or fund a few pre-election sweeteners - we suspect that he will choose the latter."

However, projections are unlikely to change significantly from those in the Pre-Budget, according to Roger Bootle at Deloitte. "The chancellor maintained a relatively cautious forecast range of 1% to 1.5% throughout the last year and is likely to stick with it in the Budget. Likewise, the forecasts for GDP growth of 3.25% per annum from 2011 onwards, while far too optimistic in my view, are also unlikely to be altered at this stage.

Capital Gains Tax (CGT)

The gap between the current rate of CGT (18%) and the top rate of income tax is set to widen further in April and this could lead more people switching investments to generate capital gains instead of income.

Matt Coward, director of private client tax services at PKF, believes Darling could announce a CGT rate as high as 25% or 40%.

"However, if the chancellor takes a more subtle approach, he might phase out the annual CGT exemption for individuals on high incomes or introduce rules to tax gains made over a short period as income," he adds.

David Kilshaw, head of private client advisory at accountancy firm KPMG, says: "The change in April 2008 to 18% with no relief for indexation was a major upheaval and it would be unhelpful to amend this again so soon. There is no justification for fixing the single CGT rate for all taxpayers by reference to an income tax rate that will apply to a small minority."


Personal allowances

KPMG expects allowances to be left at their current level.

In December 2009, the chancellor announced that the personal allowances for those under 65 would be the same in 2010/11 as in 2009/10. Since the RPI increase in February was 3.7%, this standstill in allowances is an effective increase in income tax. The chancellor announced an even greater increase for those paying tax at 40% since he intends to keep the 40% starting point at taxable income of over £37,400 from 6 April 2009 to 5 April 2013.

Accountancy Smith & Williamson says Darling could increase the 40% rate, which currently applies on earnings over £43,875 to 42% or even 45% despite it being a politically unpopular move.

Financial services firm PKF warns the chancellor could lower the threshold for the 50% income tax rate to apply, take away personal allowances at lower levels of pay or bringing forward the 1% NIC rate rise to the coming year.



This could rise to 20% from its current 17.5% level; every 1% rise brings in just under £5 billion a year so this could add around £12 billion to the government coffers.

This would have a knock-on effect on inflation - which is currently standing at 3.5%, well above the Bank of England's 2% medium term target. However, the Bank has forecast that inflation will drop back later on this year.

Stephen Herring, of BDO Stoy Hayward, says: "We expect that VAT will rise to at least 20% regardless of the colour the government.

"The Conservatives, who have a track record of hiking VAT, might be tempted to raise VAT as high as 21% or even 22%, which would still not be out of step with our European competitors. The majority of EU countries have a VAT rate of 20% or higher with some rates as high as 25%."

However, it is likely that the rise will be deferred until, perhaps, January or February 2011 to avoid a sudden dip in consumer spending derailing the nascent recovery.


Inheritance tax (IHT)

The chancellor has already frozen the IHT nil-rate band for 2010/11 at £325,000, but could tighten the rules on gifts could bring more funds into the IHT net and impose higher rates of tax on larger estates, perhaps a 50% rate on estates over £5 million.

Corporation tax

This could be cut from 28% to 25% to restore the UK's competitiveness and encourage investment in the UK.

Tobin tax

Suggestions of a levy on financial transactions are proving controversial. The Financial Services Authority chairman Lord Adair Turner has given the plans his backing while Prime Minister Gordon Brown has shied away from implementing such a tax.

Mannion of Smith & Williamson says: "Without a multi-lateral approach, markets could be severely distorted causing a loss of business to those financial centres that do apply the tax. Given that London accounts for around a third of all foreign exchange trading in the world, the UK economy could suffer significantly."

For more on the Tobin tax, read: The merits (or otherwise) of the Tobin tax.

The devil is usually in the detail. However, in this Budget the more details the chancellor can provide, the less likely the UK is to tumble headlong in credit rating downgrade hell.

With thanks to Interactive Investors.


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