What could the pre-Budget Report include?

The Chancellor, Alistair Darling will be rising to his feet in the Commons at 12.30pm on Wednesday 9 December to deliver his pre-election pre-Budget Report.

The twin consequences of the credit crunch and the recession are that tax revenues are down while government borrowing has rocketed.

How the Chancellor goes about tackling these dual, interlocked problems – raising more money without choking off the recovery – is likely to form the core of the Report.

Some things we already know for certain.

The Fiscal Responsibility Bill, announced in the Queen’s Speech, has pledged the government to halving the budget deficit, currently close to 50 per cent of GDP, within four years. How that is planned will be spelt out in the pre-Budget Report.

The standard rate of VAT will revert to its old level of 17.5 per cent at midnight on 31 December, while high earners – those on £150,000 or more – will see a hike in their income tax to 50 per cent in April 2010.

Employers’ and employees’ national insurance contributions are set to rise by 0.5 per cent in April 2011.

But what about other possible tax and economic measures?

Income tax

Mr Darling could raise the level of basic income tax or add to the rise already in place for those higher rate taxpayers; or he could lower the threshold of the 50 per cent rate to incomes of £100,000 a year.

A more likely move may be to push up the national insurance contributions of those in the upper tax bands or to impose additional restrictions on the personal tax reliefs they can claim.

Anti-avoidance will probably loom large. There is a possible 32 per cent difference between income tax rates, at the higher level, and capital gains tax. The temptation for some taxpayers is to transform income into capital as a way of sidestepping the more onerous income tax charge. The Report may set out ways and means of controlling this.

Although there are pension tax relief anti-forestalling rules in place – to head off significant switching of funds to pension pots ahead of the arrival of the new, lower relief rates which will taper to as low as 20 per cent – the Chancellor may choose to amend these further, tightening the relief available to those on £150,000 for 2010/11.

National insurance contributions

With both employers’ and employees’ national insurance contributions set to rise by 0.5 per cent in April 2011, could the Chancellor sweeten the pill by delaying the increase until the economy is firmly out of the downturn?

Capital gains tax

There may be leeway to increase CGT, currently at 18 per cent, to as much as 20 or 30 per cent. The Chancellor may soften the impact by raising the allowance threshold at which the charge becomes liable, perhaps to £25,000.

Corporation tax

The planned rise in small company corporation tax has been delayed already, and the Chancellor may wish to postpone it further.

Corporation tax for larger firms is 28 per cent. The Chancellor may propose reducing this by 3 per cent but, in return, make the rules on company losses more demanding. The scope that UK companies have for carrying forward losses against future profits is a broad, effectively indefinite one, extended, as it is, until they have accrued a similar sum in profits; imposing a time limit – possibly six years – may be an option.

Conversely, the loss carry-back scheme, introduced as a temporary recession measure, may be given another year of life.

VAT

The lowering of the standard rate to 15 per cent, as a way of encouraging consumers to spend during the recession, will come to an end on 31 December when the old rate of 17.5 per cent swings back in.

But could the Chancellor actually raise VAT, perhaps to 20 per cent? Some retailers fear he may be considering this. An increase in VAT to 20 per cent would fuel inflation – even now on the rise – but would also bring in a lot of government revenue on an annual basis.

VAT is the government’s third largest source of finance. This year alone the 15 per cent rate should add £64 billion to the public coffers, compared with the £98 billion due from national insurance contributions and the £140 billion generated by income tax.

Pumping VAT to 20 per cent would add a further £12 billion a year, the equivalent of a 3p in the pound hike in the basic rate of income tax.

Stamp duty

As part of his package of tax measures to boost the economy during the downturn, the Chancellor increased the threshold at which stamp duty becomes payable on a property from £125,00 to £175,000. The ‘holiday’ is set to end soon, but the Chancellor may look at keeping it in place for another 12 months to help the housing market.

Inheritance tax

Press reports have suggested that the Chancellor could be considering whether to impose a freeze on the current inheritance tax threshold.

At the moment inheritance tax becomes payable on estates at a value of £325,000 for a single person, climbing to £650,000 for a couple. These levels were introduced in the 2007 pre-Budget Report, with a progressive rise to £350,000 for a single person and to £700,000 for a couple set for April 2010.

However, the Chancellor may be obliged to concede that the tax cut is no longer affordable. His options could include going ahead with the planned rise to £350,000 and £700,000 but then freezing the increase for a number of years, or dropping the new thresholds altogether and holding them at the present levels.

A Treasury spokesman would not be drawn on the question, saying that all “taxes are kept under review” and that all “policies will be announced in the Budget and pre-Budget Report”.

The economy

It is entirely possible that Mr Darling will be forced to concede that the economy has turned in a worse performance in 2009 than he had predicted.

The March Budget forecast was for a contraction of 3.5 per cent; that figure now looks optimistic, with the rate of decline likely to hit 4.75 per cent.

The main damage was inflicted in the first three months of the year when the global downturn was particularly severe.

But while Mr Darling may revise his estimates for 2009, he is expected to hold to his prediction of a return to growth of between 1 per cent and 1.5 per cent for 2010.

As far as public spending is concerned, policy rests on the horns of a dilemma. Government expenditure has been a mainstay in keeping the rise in unemployment to manageable levels. To turn off the taps now could imperil the rate at which economic recovery is staged. But with government borrowing set to hit £175 billion this year, some cuts may need to be made sooner rather than later.

One radical route would be to freeze public sector pay awards in an effort to recover the fiscal position.