Key Tax Provisions from the UK’s 2020 Budget

Today, the Chancellor of the Exchequer, Rishi Sunak, released the 2020 budget for the UK. While a significant part of the budget provides funding to address the short-term risks and threats to the UK population and economy from coronavirus (COVID-19), there were several tax policies that are unrelated to the virus.

According to the Office of Budget Responsibility, the overall budget represents the UK’s largest fiscal expansion since 1992. This includes an annual increase in the budget deficit by 0.1 percent of GDP on average over the next five years.

The Chancellor proposed several changes on business taxes, individual taxes, consumption taxes, and property taxes that will reduce the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. burden. Additionally, several policies that were previously set in motion will continue.

The UK currently ranks 25^th out of the 36 OECD countries on our International Tax Competitiveness Index. However, the handful of reforms in the 2020 budget will not likely improve the country’s ranking in any significant way.

Business Taxes

The Chancellor’s budget makes a handful of changes to tax policies that will impact businesses.

First, the research and development expenditure credit (RDEC) rate will increase from 12 percent to 13 percent. The RDEC rate is the share of qualifying business R&D spending that can be claimed as tax relief. The increased RDEC rate will reduce revenues by £1 billion over the next five years.

Second, the structures and buildings allowance rate will increase from 2 percent to 3 percent. This policy improves the UK’s cost recovery system. The higher allowance rate will reduce revenues by £1 billion over the next five years.

Cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. is the ability of businesses to recover (deduct) the costs of their investments through depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. schedules. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker productivity and wages.

The increase in the structures and buildings allowance rate will increase the net present value of capital allowances for buildings from 27.9 percent to 39 percent. The average among OECD countries is 48.9 percent.

Third, the budget makes a technical change to the digital services tax (DST). The DST, which goes into effect on April 1, was originally designed to have quarterly tax payments. This budget changes the payment schedule from quarterly to annually.

In January, the U.S. and France agreed to have collection of a similar French tax delayed until the end of 2020. At the same time, a similar deal was struck with the UK. This change in the 2020 budget helps to clarify how the UK is navigating the current OECD negotiations on digital taxation and the U.S. Trade Representative’s response to the French DST.

The DST is a particularly distortionary and complex proposal, and it would effectively place a 2 percent tariffTariffs are taxes imposed by one country on goods imported from another country. Tariffs are trade barriers that raise prices, reduce available quantities of goods and services for US businesses and consumers, and create an economic burden on foreign exporters. on some digital services in the UK. The original proposal was projected to raise £1.4 billion over five years. The technical change only slightly impacts that original projection.

Income Taxes

Two of the largest tax changes in this budget change taxes on individual income.

First, the primary threshold and lower profit limits for National Insurance Contributions are set to increase to £9,500 from approximately £8,600. The primary threshold is the trigger for liability to pay National Insurance Contributions. Increasing the threshold will lower the tax burden on lower-wage workers. However, the change comes at a significant revenue loss of £11.4 billion. This policy also fulfills a commitment from the Conservative Party Manifesto. The manifesto also promises an eventual increase in the primary threshold to £12,500.

Second, the budget proposes reducing the Entrepreneur’s Relief lifetime limit from £10 million to £1 million. The relief is a lower capital gains tax rate of 10 percent on gains made by sole proprietors and partnerships. Above the lifetime limit, gains are taxed at the standard capital gains rate (28 percent for residential property or 20 percent on other assets).

According to recent research on Entrepreneur’s Relief, the policy is not well-targeted to increase investment, and creates opportunities for businesses to avoid paying higher capital gains taxes.

Lowering the lifetime limit will increase revenues by £6.3 billion over the next five years.

Consumption Taxes

Consumption taxes accounted for 32 percent of all tax revenue in the UK in 2018. The UK has relatively high excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. rates and a relatively narrow tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. for its value-added tax (VAT). The 2020 budget would maintain current rates on certain excise duties and narrow the VAT base further.

The proposals on excise duties include (for 2021-2022) temporarily freezing tax rates on:

• Fuel
• Alcohol

Absent the temporary freeze, the duties would increase at the rates of inflation, measured by the Retail Price Index.

The fuel duty freeze is expected to reduce revenues by £2.7 billion over the next five years, and the alcohol duty freeze will reduce revenue by £1 billion over the next five years. The UK currently has among the highest rates of tax on alcohol in Europe, including taxes on beer, wine, and sparkling wine. Gas taxes are also relatively high in the UK.

The budget also promises some changes to the UK VAT. These include:

• Zero-rating e-publications
• Abolish VAT on female sanitary products

The UK currently ranks last in the International Tax Competitiveness Index due to the narrowness of its VAT tax base. Both 2020 budget proposals will make this situation worse. The numerous exemptions and reduced rates in the UK VAT contribute to numerous distortions in consumer and business behavior.

Zero-rating e-publications is expected to reduce revenues by £810 million, and the removal of female sanitary products from the VAT base will reduce revenue by £65 million over the next five years.

Property Taxes

Temporary and targeted changes to business rates (property taxes on businesses) are also included in the 2020 budget.

First, the small retailer discount for business rates was increased from 33 percent to 50 percent for next year. This applies to shops, cafes, restaurants, cinemas, and music venues with property values (for property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. purposes) of less than £51,000. Previously, cinemas and music venues were excluded from the policy. The policy will reduce revenues by £270 million over the next year.

Second, the budget proposes a £1,000 discount for pubs with property values (for property tax purposes) of less than £100,000 for the next year. This reduces revenues by £20 million over the next year. The Chancellor specifically mentioned the impact that COVID-19 might have on the pub industry as a reason for relief in this sector.

Conclusion

While the new UK budget is an aggressive fiscal expansion overall, the tax changes it envisions are relatively small reforms around the edges. In order to improve competitiveness, policymakers in the UK will need to widen the lens and explore more fundamental reforms to the tax system that will create both a more competitive and neutral tax system.

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