In focus

Who will pay for the £370 billion Covid-19 borrowing?

The UK’s response to Covid-19 has involved enormous and sustained public spending. This will mean huge deficits in the short term, but also a significant increase in national debt likely to persist for decades.

The Government had dropped its earlier objective to balance the budget by the mid-2020s long before the outbreak of Covid-19, believing that low borrowing costs justified maintaining modest deficits. But the pandemic has caused those deficits to balloon.

The Office for Budget Responsibility now predicts this year’s borrowing to reach £370 billion, or up to 23% of national income*. This is more than double the borrowing following the financial crisis and close to annual levels of borrowing last experienced in the Second World War.

Looking ahead: public spending vs tax receipts


Source: Office for Budget Responsibility, July 2020

Longer-term this will dramatically increase the UK’s national debt. Higher deficits today will continue, albeit to a lesser extent, in coming years, as the UK’s economy suffers post-Covid “scarring”. Without some form of tightening, the UK’s public sector debt, which in June reached 99.6% of national income**, is predicted to rise to 200% by the 2040s.

This is roughly twice the level forecast before the pandemic.

What can the Chancellor do in the face of this crisis? As the Office for Budget Responsibility and others have made clear in recent weeks, there is one obvious answer: more tax.

Raising taxes: the Government’s predicament

The Government is in a bind. In 2019 the Conservatives promised that “we will not raise the rate of income tax, VAT or National Insurance”. Yet these are the three primary ways in which meaningful revenues are raised.

HMRC’s total receipts for 2019-20 were £635 billion, of which the biggest contributors by far were income tax (£194 billion), VAT (£130 billion) and NI (£143 billion)***.

Corporation tax – paid by businesses – is another big income source, at £61 billion, but we think it highly unlikely this will be raised, given the emphasis on economic recovery and the plight of many sectors. Investment companies however, could be targeted.

Contributions of major taxes to the Exchequer

Total tax receipts (2019-20) £635 billion
Of which... Income tax £194 billion
VAT £130 billion
National Insurance contributions £143 billion
Corporation tax £61 billion
Stamp duty land tax £12 billion
Capital gains tax £10 billion
Inheritance tax £5 billion

Source: HMRC, June 2020

Hence the most obvious routes to raise revenue are closed to the Government or entail breaking manifesto pledges. We think the latter very likely. Chancellor Rishi Sunak will say the extreme circumstances justify dropping the pledge, and we anticipate increases in income tax at the upper end, as well as potential National Insurance reform.

We may also see a reduction in income tax reliefs, including those applying to pension contributions, as part of future efforts to raise revenues from income.

Narrowing in on capital gains and inheritances

We see two trends emerging, both of which will result in higher taxes being levied on investors’ capital and inherited wealth.

The first is a growing political argument – voiced across the political spectrum – of the need to improve social equality. Boris Johnson speaks of “levelling up” the UK, and in policy terms this implies taxing the wealthy (and being seen to do so).

Secondly, our current tax regime is increasingly viewed as favouring asset owners over income earners. Tax rates on capital gains are significantly lower than for earned income, for example, with gains on share disposals attracting a top rate of 20% compared to the top rate of 45% on earned income. Investors’ assets can be structured to benefit from these discrepancies, it is argued – something the Government now appears to want to halt.

Earlier this month Chancellor Rishi Sunak ordered a root-and-branch review of capital gains tax, including an examination of “the interactions of how gains are taxed compared to other types of income.”

For both of the above reasons we anticipate increases in capital gains tax.

We expect similar principles to apply to inheritance tax. Like capital gains tax, it currently contributes relatively little to HMRC’s total pot. But because it is paid by a small minority of wealthier households, it has political significance.

How these increases could be implemented, in terms of reduced allowances, higher rates, or the removal of exemptions, including those applying to property, we will explore in future papers.

Why we think a “wealth tax” is unlikely

There has been speculation about taxing wealth through the imposition of a tax applied across an investors’ assets above a defined threshold.

We think this unlikely. There is evidence from other countries that this tax is difficult to administer, unpopular and unsuccessful, and it may be a step too far for a Conservative government. However, the success of a wealth tax is generally measured in political terms rather than in revenue; it is a very visible tax on the wealthy. A tool used effectively at a time when those further down the wealth brackets are having to stump up extra taxes. As such it cannot be ruled out. In any case, we expect the Government to introduce other forms of tax – outlined above – enabling it to demonstrate its “levelling up” agenda and as such view it an unlikely addition to the tax landscape in the UK.

How will this affect you and your wealth?

In our view you are likely to be subject to higher taxes overall, but these increases will be felt through a range of measures.

In some cases this will be higher tax rates, in other cases it will be the loss of exemptions and allowances.

The Government’s first priority as the UK exits lockdown will be to assist in driving economic growth and employment. Addressing the longer-term effects of our enormous deficits will come later. But the need to balance the books, coupled with political motives, will see tax changes beginning to be implemented as early as November 2020 in the Chancellor’s Autumn Statement.

This allows you some time to assess your position and organise your affairs, if necessary. In particular you may want to make use of current rules and allowances as they stand today.

Statements concerning taxation are based on our understanding of the taxation law in force at the time of publication. The levels and bases of, and reliefs from, taxation may change. You should obtain professional advice on taxation where appropriate before proceeding with any investment.

*Office for Budget Responsibility, Fiscal Sustainability Report 2020, July 2020.

**Office for National Statistics, UK Government Debt

***HMRC, June 2020

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.

This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.

All data contained within this document is sourced from Cazenove Capital unless otherwise stated.