Has the tax credits defeat left the tax system vulnerable?

28 October 2015

George Bull 

The Chancellor George Osborne has been dealt a hefty blow this week after peers voted against a decision by government to make major changes to the tax credits system. Mr Osborne has said he will now review his decision, but has made it very clear he will press ahead with changes that will save billions in welfare payments.

So what’s the Chancellor to do next? 

Firstly, let’s make one thing clear. It’s very likely that tax credit changes will be enforced at some later stage, but probably later than scheduled and with less severity. But with one month to go before a spending review that could have complemented his Budget last July, he has just a few weeks to plug the shortfall and prevent his austerity plans derailing.

There is a possibility that he will change the way they are introduced by ensuring that the restriction only applies to new claimants, but this will result in a shortfall in closing the deficit gap. We can also be fairly certain that he won't want to ‎increase borrowing, and it’s unlikely he will be able to raise any of the income tax rates because of the triple lock. I also don't think he'll use the proposed new high corporation tax rate on interest supplement to plug the gap either, as that exists to reduce the outflow of public funds in the form of interest payments

More worryingly, it’s possible that the Chancellor may now look to use the tax system to do exactly this. Some of the options he may be exploring could include: 

  • Tinkering with the starting point of income tax rates. 
  • Aligning NI and income tax which could mean an extra £300 a year in the pocket of someone at the lower end of the pay scale, potentially paving the way for the inevitable changes to tax credits at a slightly later date. Coincidentally, the OTS is consulting on this, and there are more details on this in Gary Heynes’ article
  • Delay the increase to personal allowances
  • Increases to Capital Gains Tax – which we previously predicted in Weekly Tax Brief.
  • Delays to the IHT enhancement to main residence (less likely I think as it's a key Conservative pledge). But increasing the 45% rate to 50% looks unlikely as this is unlikely to be sufficient.
  • Delayed reduction in the corporation tax.
  • A greater focus on tax avoidance and evasion.

It’s likely that if there are any tax increases then they’ll be introduced next month, which is going to make for an interesting Autumn statement...