Budget 2005: a question of 'vote now, pay later'?
The chancellor's supporters viewed the 2005 Budget as prudent and cautious, while his detractors insist that pre-election "giveaways" will have to be paid for with higher taxes.
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Key points
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This was chancellor Gordon Brown's ninth, and possibly last, Budget. With the smart money on a May 2005 general election, his 50-minute oration was keenly assessed by commentators for its vote-winning potential, as much as for its effect on the nation's economy1 (see box 1). Against this background, it came as no real surprise that he trumpeted the fact that gross domestic product (GDP) has grown for 50 consecutive quarters. This means that the UK is currently experiencing its longest unbroken period of economic expansion since quarterly national accounts data were first kept in 1701.
As the documentation accompanying the 2005 Budget also boasts, "with volatility in the UK economy at historically low levels, and now the lowest in the G7 [the group of the world's leading industrial nations], the domestic stability delivered by the government's macroeconomic framework puts the UK in a strong position to respond to the global economic challenges of the next decade." Neither is it a surprise that, as confidently predicted by the chancellor at the time of the 2004 pre-Budget report , Gordon Brown has again adhered to his "golden rule" - this states that, over the economic cycle, the government will only borrow to invest, and not to fund current spending - but only just2.
In a distinct nod towards the electorate, the chancellor announced some headline-grabbing "giveaways" - notably those aimed at pensioners, home buyers, and poorer families - although his room for manoeuvre was circumscribed by a growing deficit. In reality, the devil is in the detail, with the documentation accompanying the Budget speech revealing that, while Gordon Brown has given away some £2 billion for 2005-06, he actually plans to raise an additional £2.2 billion over the same period. Despite this modest tightening in policy, many City commentators remain convinced that taxes will have to rise, perhaps by up to £10 billion, once the election is out of the way.
Nevertheless, Gordon Brown remains bullish, maintaining that his sums are correct, and brushing aside the nagging doubts expressed by many analysts. To be fair to the chancellor, he has been proved to be largely correct thus far, particularly in relation to his forecasts for economic growth. For 2004 as a whole, UK GDP increased by 3.1%, its fastest rate of expansion for four years, and consistent with the 3%-3.5% forecast range that the government has adhered to since the 2002 pre-Budget report. According to the Treasury, as world growth retains much of its upward momentum, and with UK business and consumer confidence still strong, GDP is expected to grow by between 3% and 3.5% in 2005. However, as the remaining slack in the economy is absorbed, and the "output gap" is closed towards the end of the year, the economy is forecast to grow in line with trend by between 2.5% and 3% in 2006.
Pay and employment-related aspects
As Gordon Brown's 2005 Budget was delivered barely three months after he gave his state-of-play review of the UK economy in the December 2004 pre-Budget report, it comes as little surprise that the chancellor's latest package contains few, if any, shocks. However, there are still a number of measures of interest to pay and HR practitioners (see box 2). These include an increase in the national insurance contribution (NIC) thresholds in line with inflation, with the starting point for both employers' and employees' NICs increasing to £94 a week from 6 April 2005 (see table 1).
unchanged rates of income tax, remaining at 10% (starting rate); 22% (basic rate); and 40% (higher rate);
an indexation of the 10% starting rate income tax band, increasing it from £0-£2,020 to £0-£2,090 a year;
a rise, in line with inflation, in the basic rate income tax limit so that it now applies to annual income between £2,091 and £32,400;
an increase, again in line with inflation, in the personal income tax allowance for those under 65, taking it from £4,745 to £4,895;
an uplift, in line with earnings, in the personal allowance for those aged 65 and over from £6,830 to £7,090 for those between 65 and 74, and from £6,950 to £7,220 for those aged 75 and above;
as announced in the 2004 pre-Budget report, a rise of £65 in the child element of the Child Tax Credit (CTC), taking it to £1,690 a year. The child element of the CTC will rise at least in line with earnings in both 2006-07 and 2007-08; and
again, as announced in the 2004 pre-Budget report, the limits on the costs of eligible childcare within the childcare element of the Working Tax Credit (WTC) will rise from 6 April 2005 to £175 a week for one child, and £300 a week for two or more children. The maximum proportion of costs that can be claimed within the childcare element of the WTC will increase from 70% to 80% from 6 April 2006.
On childcare, the Budget confirms that, from 6 April 2005, the £50 a week tax and NI exemption on employer-provided childcare vouchers will apply to the face value of the vouchers, with the additional associated administration costs and service charges also exempt from income tax and NICs.
Elsewhere, the Inland Revenue is to issue "targeted publicity" to make employees aware of the changes to the way the WTC is paid. In addition, employers will be required to send one "targeted letter" to individual employees shortly before the phasing out begins to explain the changes.
The Inland Revenue will be consulting employers' representatives about the arrangements for phasing out payments via employers. For further details of these changes, you are advised to contact your local Inland Revenue enquiry office, or contact the Employer Helpline on 0845 714 3143.
Company cars
The taxation of company cars was reformed in April 2002 to reflect carbon dioxide emissions, and to encourage drivers to opt for more environmentally friendly cars. In April 2004, the Inland Revenue published an evaluation of the scheme. This indicated that it had indeed been successful in both reducing business mileage and lowering emissions. The Budget notes that the working of the scheme will continue to be monitored to ensure that it meets the government's environmental aims. As previously announced, the level of emissions qualifying for the minimum company car tax petrol percentage (15%) will reduce from 6 April 2005 by 5 grams per kilometre, from 145 to 140 grams per kilometre. This is also applicable to the 2006-07 tax year. The 2005 Budget pegs the minimum percentage charge rate at 140g per kilometre for 2007-08.
Similarly, the company car fuel benefit charge was reformed in 2003 to bring it into line with the carbon emissions basis of the company car system. Fuel benefit is calculated by multiplying the company car tax percentage band for the vehicle in question by a set figure that, since April 2003, has been set at £14,400. The Budget freezes this figure at £14,400 for 2005-06.
Meeting the "productivity challenge"
According to the government, productivity growth "underpins strong economic performance and sustained increases in living standards". With this in mind, the chancellor announced a number of steps that, he maintains, will strengthen the UK's competitive performance. These include:
A reduction in business regulation, including the introduction of a "risk-based" approach to both inspection and enforcement.
Plans to enhance the skills of the workforce, with a white paper to be published shortly which, the government says, will "set out the next phase of reform to make this country a world leader in skills . . . by putting employers' needs centre-stage in the design and delivery of training and supporting individuals to gain the skills and qualifications they need to achieve at all levels, from basic skills in literacy and language, through to Foundation Degrees".
Employer training pilots were introduced in September 2002 to address market failures that restrict businesses and individuals from investing in skills training. The government plans to build on the success of the pilots by rolling out a national employer training programme from 2006-07, to cover the whole country by 2007-08. This will guarantee that, where employers are prepared to offer their low-skilled employees paid time off to train up to NVQ level 2 qualifications, the costs of the training will be fully subsidised. Further evaluation will be undertaken before a decision is made as whether an element of wage compensation will be included within the national programme.
Economic outlook
At the time of the 2004 pre-Budget report, released in December last year, Gordon Brown maintained, in the face of much scepticism among City commentators, that he remained on course to meet the most prominent of his fiscal targets - the "golden rule". This states that, over the economic cycle, the government will only borrow to invest, and not to fund current spending. Based on the Treasury's "cautious assumptions" about key economic variables, including growth, he forecast an average surplus of 0.1% of GDP over the rest of the current economic cycle, due to end in the latter part of this year. Thereafter, the average annual current account surplus from 2005-06 to the end of the forecast period in 2009/10 was predicted to be a more comfortable 0.25% of GDP.
Although the 2005 Budget confirms this view, with an average annual surplus on the current account predicted to be some £6 billion over the present economic cycle, it should be noted that, at the start of the cycle, the Treasury confidently forecast that the average surplus would be at least 0.5% of GDP. Thus, while Gordon Brown has avoided the political embarrassment of breaking the "golden rule", he has done so by a thin, and ever-decreasing, margin. In light of this, it is perhaps unsurprising that many commentators expect taxes to rise, perhaps substantially, after the next general election to fund rising public expenditure. Other significant economic forecasts and assumptions contained in the 2005 Budget include:
Prices: the government's preferred measure of inflation, the consumer prices index (CPI) has picked up a little since the time of the 2004 pre-Budget report although, the Treasury says, inflationary pressures "remain firmly under control". CPI inflation averaged 1.3% in 2004, marginally lower than in 2003 and a little under its 2% target. However, in both December 2004 and January 2005, it stood at 1.6%, up from a recent low of 1.1% and the highest rate for six months. Rising electricity and gas prices are mostly to blame, the Treasury says.
Despite this, the inflationary outlook remains the same as forecast in the pre-Budget report, with the CPI target unchanged at 2%. As 2005 unfolds, the absorption of the remaining slack within the economy is expected to remove one recent source of downward pressure on prices. At the same time, the Budget documentation notes, the effects of strong global growth, and its ongoing boost to UK external demand, are expected to continue to feed through to higher import prices, helping push the CPI figure up towards its target figure by the middle of 2006.
Growth: the Treasury proudly boasts that the UK's GDP increased by 3.1% in 2004, above its trend rate, and the fastest rate of expansion for some four years - this despite the fact that growth dipped slightly below trend during the third quarter of last year. The economy has largely performed in line with the projections made at the time of the 2004 pre-Budget report, with GDP growth pitched at 0.7% in the fourth quarter of last year (2.9% year-on-year). For 2004 as a whole, the economy grew by an estimated 3.1%, consistent with the 3%-3.5% Treasury projection.
For 2005, Gordon Brown expects the UK's economy to again expand by between 3% and 3.5%. Growth is then expected to return to between 2.5% and 3%, in line with the economy's trend rate.
Taxation and spending: the Treasury's "Red Book", which accompanies the Budget speech and contains much of the fine economic detail, reveals that Gordon Brown expects revenues to be £449.7 billion in 2004-05, rising to £487 billion and £520 billion in 2005-06 and 2006-07 respectively. Against this, the government expects to spend £451.1 billion in 2004-05. This means that, with depreciation, the budget deficit will be pitched at £16.1 billion for 2004-05 (1.4% of GDP). This is around £3.5 billion higher than forecast in the 2004 pre-Budget report, and is explained, the Treasury says, by higher than expected current expenditure, primarily relating to the timing of net payments to the European Union, and additional money allocated to meet the UK's international commitments.
In 2005-06, the deficit is forecast to fall to £6 billion, aided by lower-than-expected spending, with a projected surplus of £1 billion for 2006-07.
The major discretionary measures announced in the 2005 Budget include a commitment to increase the child element of the Child Tax Credit in line with average earnings up to 2007-08: a guarantee that council tax-paying households with someone over 65 will receive a one-off payment of £200 towards the cost of council tax; and a further modernisation pf the tax system (including doubling the threshold for stamp duty on house purchases). However, according to The Treasury, the combined effect of these measures will "only have a small effect on the current budget."
1Budget Report 2005 - Investing for Our Future: Fairness and Opportunity for Britain's Hard-working Families, March 2005, available from HM Treasury, tel: 020 7270 4558, price £45. Also available at www.hm-treasury.gov.uk.
2Pre-Budget Report 2004 - Opportunity for All: the Strength to Take the Long-term Decisions for Britain, December 2004, available from HM Treasury, tel: 020 7270 4558, price £45. Also available at www.hm-treasury.gov.uk.
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Budgets are inevitably followed by a deluge of analysis, comment, criticism, and sometimes even praise, from organisations representing various interest and pressure groups. Below, we give a flavour of the reactions to the chancellor's speech. TGWU The Transport and General Workers' Union is one of the UK's largest trade unions. Its general secretary, Tony Woodley, said the Budget "would be good for Britain, and would be particularly welcomed by those most in need of government support: pensioners and parents". While the union welcomed the measures to assist industry, notably those relating to skills, research and development, Woodley did warn that "British manufacturing needs tough action to stem job losses … The economic stability that the government has delivered means business has all the right conditions to promote the high skill, high productivity economy we need to compete with the rest of the world." CBI The voice of Britain's business community, the CBI, welcomed what it described as a "balanced Budget that looked beyond short-term political concerns". The organisation's director general, Sir Digby Jones, commented that the chancellor's package was crafted to "ensure economic stability is maintained", avoiding the temptation of pre-election risk-taking. In common with the TWGU, the CBI also supported measures to improve the skills base of the workforce, noting that by 2010, 80% of all new jobs will require higher-level skills. "Red tape" has long been a bugbear of business, and so the CBI's approval of further deregulation will therefore come as no surprise. Unison Commenting on the Budget, the union's newly re-elected general secretary, Dave Prentis, said that the chancellor showed "no sign of election fever … targeting benefits at those who really need them - pensioners, working families and children". The vast majority of Unison's 1.3 million members work in the public sector, and so Gordon Brown's plans for this key part of the economy are of particular interest to this giant of the labour movement. "The Budget reflects the peoples' priorities of better public services, better schools and better hospitals," Prentis stated. However, the union was far less impressed with the government's plans to axe 12,500 civil service posts in the coming year: "Swinging job cuts threaten to undermine the delivery of front-line public services - these are real people doing real jobs," he warned. Institute of Directors The Institute of Directors (IoD) is a non party-political business organisation with around 55,000 individual members. Its director general, Miles Templeman, gave his broad support to the Budget, particularly Gordon Brown's deregulation proposals. Nevertheless, the IoD still has reservations about the government's fiscal stance, predicting that a "rising burden of taxation" over the next five years will have what it regards as a negative impact on economic growth. To deal with this potential problem, the IoD called on the chancellor to introduce what it calls a "third fiscal rule" - a commitment to reduce the overall level of taxation as a proportion of gross domestic product over the economic cycle. |
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Box 2: The 2005 Budget - the main pay, benefit and employment-related changes National insurance contributions National insurance contribution (NIC) rates and thresholds for 2005/06 are as follows: the secondary threshold, the point at which NICs start, rises in line with inflation from £91 to £94 a week for both employers and employees, effective from 6 April 2005;
the upper earnings limit on employee contributions rises by £20 a week to £630 (£32,760 a year). This means that, from 6 April 2005, employees pay NICs set at 11% on weekly earnings between £94.01 and £630. In addition, employees pay NICs set at 1% on all weekly earnings above £630; and
employer NICs, paid on employee earnings above £94 a week, are set at 12.8%. There is no upper limit on employer contribution rates. See table 1 for details of the new NIC rates.
Income tax Changes to the income tax regime, which take effect from 6 April 2005, are as follows: the basic personal allowance (the first part of income on which no tax is paid) increases by £150 to £4,895 a year;
the starting rate threshold (the point at which workers begin to pay the 10% tax rate) increases in line with inflation from £2,020 to £2,090;
the basic rate of income tax remains unchanged at 22%, and is payable on annual income between £2,090 and £32,400; and
the higher rate of income tax also remains unchanged at 40%, while the threshold for the payment of the higher rate increases in line with inflation, and now applies to all income over £32,400 a year.
See table 2 and table 3 for details of income tax rates and revised allowances. Company cars According to Inland Revenue rules, where a car is made available for an employee's private use, a taxable benefit arises. Company car tax was reformed in April 2002 and is now calculated by applying a percentage to the list price of the car. The percentage is related to the CO2 emissions of the vehicle, and ranges (in 1% increments) from 15% to 35% for a petrol car. Diesel cars that do not meet Euro IV emissions standards attract a 3% supplement on the petrol percentages (capped at 35%). The 2004 pre-Budget report announced that from April 2006, the waiver of the 3% supplement for diesel cars meeting Euro IV standards will be withdrawn for cars registered from 1 January 2006. The CO2 emissions qualifying for the minimum petrol percentage charge have been set at 140 grams per kilometre of CO2 for both 2005-06 and 2006-07. For 2007-08 the level of CO2 emissions qualifying for the minimum petroleum percentage (15%) will be frozen at 140 grams per kilometre of CO2. An additional taxable benefit arises if the employee receives free fuel for the company car for their private use. The taxable benefit calculation was reformed in April 2003 to align the charge with the environmental principles of the company car tax system. Since April 2003, the fuel benefit charge has been calculated by applying the company car tax appropriate percentage to a set figure. In 2004-05 the figure was £14,400. For 2005-06, the figure for the company car fuel benefit charge will be frozen at £14,400. Child tax credit A child tax credit (CTC) was introduced in April 2003, replacing the child elements of the working families' tax credit, the disabled person's tax credit, income support or jobseekers' allowance, and the children's tax credit. Paid on top of child benefit and directly into the bank account of the main carer, the CTC provides, from 6 April 2005, a child element of £1,690 a year, up from £1,625. The family element of £545 a year remains unchanged. Working tax credit The working tax credit (WTC) has replaced both the
working families' and disabled person's tax credits. In conjunction with
the minimum wage, it is designed to tackle poverty among those in
employment. From 6 April 2005, the basic element of the WTC will rise with
inflation from £1,570 to £1,620 a year, with the couple and lone parent
element rising from £1,545 to £1,595. Other elements of the WTC also rise
in line with inflation. |
Table 1: National insurance contributions from 6.4.051
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Weekly earnings |
National insurance rate for employees |
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Up to £94 |
Nil |
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£94 to £630 |
11% of £94.01 to £630 per week |
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Over £630 |
1% |
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Weekly earnings |
National insurance rate for employers |
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Up to £94 |
Nil |
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Over £94 |
12.8% |
1 NICs to be paid on all taxable benefits in kind, excluding childcare.
Table 2: Income tax rates from 6.4.05
|
Tax rate |
Bands of taxable income |
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Starting rate (10%) |
Up to £2,090 |
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Basic rate (22%) |
£2,091-£32,400 |
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Higher rate (40%) |
Over £32,400 |
Table 3: The Budget - key personal finance changes
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Allowances |
£pa |
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Income tax - tax year from 6.4.05 |
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Personal allowance |
£4,895 |
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Blind person's allowance |
£1,610 |
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Income limit for age-related allowances |
£19,500 |
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£pw |
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National insurance - effective 6.4.05 |
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Secondary threshold |
94 |
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Upper earnings limit |
630 |
