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Summer budget cuts welfare and raises minimum wage

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Neil Williams, Group Chief Economist at Hermes Investment Management comments on the UK’s Summer Budget that, with it coming at a politically advantageous time at the start of the term, was designed to correct up to GBP17 billion in spending slippage relative to plans.

Williams says: “The onus as expected will fall on targeted welfare cuts, which together with the raising of personal tax thresholds and a national living wage, the Chancellor hopes to incentivise more people into work. In hard macro terms, time will tell how this trade-off plays out in sustaining what’s been an impressive UK growth-momentum. Given his aim was flagged in advance, it should not surprise financial markets.”
 
Williams believes that equities and conventional gilts should welcome the preservation of the Chancellor’s growth projections and forthcoming corporation tax and bank levy cuts. “But, the ‘only’ GBP3.5 billion lower gilts supply now planned for 2015/16 (at GBP127.5 billion) will disappoint some, given the coming proceeds from bank asset sales, and inevitable political temptation of tax cuts at the end of this Parliament” he comments.
 
 “The fiscal screw will have to stay tight if the underlying budget deficit is to be whittled down and returned to the black in 2019/20 – one year later than expected in his March Budget. Recovery has helped, but better growth should have squeezed the deficit more than it has.”
 
Williams feels that the deficit is still high: “Even including special items like the transfer of the Royal Mail Pension Plan and QE profits, the near 5 per cent-of-GDP headline deficit for 2014/15 was still the G7’s widest after Japan.”
 
 He warns that while the headline deficit falls on better growth, the structural, less growth-sensitive part of the deficit will fall by less, begging further reform and consolidation. “And, only last year is the net-debt-to-GDP ratio expected to have peaked, at 81per cent – disappointing given real GDP is 5 per cent up on its pre-crisis peak. This 81 per cent ratio is more than twice Japan’s was, when Japan limped into a ‘lost decade’ in the mid-1990s.”
 
Williams believes that the first Bank of England rate hike still looks unlikely until around the next scheduled Budget, in spring 2016.
 
Commenting on the effect of the tapering of mortgage tax relief that can be claimed by buy-to-let landlords, Guy Ellison, Head of UK equities at Investec Wealth & Investment says: “We’ve seen a sell-off in house builders, estate agencies and those linked to finance within the buy-to-let market as the government will start to taper down the amount of mortgage tax relief that can be claimed by buy to let landlords to the minimum tax rate from 2017.”
 
He also notes that national living wage will see an 11 per cent uplift from GBP6.50 to GBP7.20 next April for those on the minimum wage, weighing most heavily on the biggest employers such as retailers, leisure and support service companies.
 
“Businesses will rejoice at a further reduction to corporation tax to 18 per cent in 2020 which will maintain and indeed further the UK’s position as having one of the lowest corporate tax rates of any developed nation. The effect of a reduction in Bank levy over six years should be monitored closely; whatever is left of the levy will only be focused on UK balance sheets, but the reduction and narrower focus will be offset by an 8 per cent incremental taxation on bank profits from January 2016. This could potentially hit domestically-focused and ‘challenger’ banks hardest.”
 
Paul Latham, Managing Director at Octopus Investments found little surprise in the Budget’s stance on property IHT. “Official confirmation that the Government will be gradually increasing the nil rate band on property people leave to their children or grandchildren will no doubt be welcomed by many. With a significant amount of people’s wealth in the UK tied up in their home, today’s news will provide comfort that their family can now benefit from this nest egg. The nil rate band for inheritance tax was fixed at the current level back in April 2009. Since then, house prices have soared by 44 per cent so it’s good to see the new Family Home Allowance take account of this and bring IHT legislation in line with today’s property market.”
 
Latham feels that while this is a positive step, for many it will be of limited value. “With the cost of the average house in the UK predicted to rise by 22.8 per cent over the next five years, a significant number of couples’ homes are likely to exceed the GBP1 million threshold by the time the change comes into full effect in 2021” he comments.
 
“Many people also hold assets other than their homes that may be liable for IHT when they die. In order to take full advantage of the increase in relief, a couple cannot have used up any of their nil rate band in the last seven years. There are also restrictions on who the beneficiaries can be in order to qualify for it and the additional relief diminishes after a GBP2 million cap for every couple, meaning that it is totally removed for those with a combined wealth over GBP2.35 million. In recent months there has been uncertainty over how changes might impact individual circumstances. However with the existing nil rate band of GBP325,000 on assets excluding property also now fixed until 2021, it is now clear that for many, there remains a very real need for advice on how to maximise the inheritance they can leave behind.”
 
Latham continues: “With life expectancy on the rise and the unpredictability of later years and cost of potential care to consider, the challenge for many people is knowing how much to place into an inheritance pot. However, there are some options available to investors, such as investments in shares that qualify for Business Property Relief, which give greater levels of access to and control of their money than other more traditional solutions, so they can be flexible in their planning.”
 
“In addition to this, the tapering of tax relief on pensions contributions for those earning over GBP150,000 means that affected investors and their advisers may want to explore alternative tax efficient investments, such as Venture Capital Trusts and Enterprise Investment Schemes, to complement their existing retirement planning arrangements.”
 
Rachael Griffin, financial planning expert at Old Mutual Wealth also commented on the freezing of the IHT allowance, which she says negates the real impact of the GBP1 million property exemption.  “Looking at house price inflation since IHT was frozen back in 2009, prices have risen on average by 7.3 per cent a year (based on the mix adjusted rate). If the IHT allowance for a couple, currently GBP650,000, rose in line with house price inflation (based on a predicted 7.3 per cent ‘simple’ growth rate), by the time we get to 2020/21 the allowance could have be nearing the GBP1 million mark anyway (GBP934,700).”
 
Griffin feels that this means the enhancement introduced in today’s budget has added extra complexity to the IHT system without benefiting people in any real way. Increasing the IHT allowance in line with house price inflation would have been a more robust and cleaner solution.
 
 “If we take the calculation back even further to when IHT was first frozen in April 2009 the increase would in fact be negative in real terms. Since April 2009 average house prices have risen by 36.6 per cent (based on the mix adjusted rate). If IHT had kept pace with house price inflation, the GBP650,000 joint IHT allowance would stand at GBP887,900 today. Add onto this the projected rise calculated above and the IHT allowance could have been worth (GBP887,900 + 43.8 per cent) GBP1,276,800. This means the GBP1 million IHT property exemption will, over time, have a negative impact in real terms. In 2020/21 we predict it could have a negative impact in real terms of GBP276,800.”
 
Turning to pensions, Carlton Hood, customer director at Old Mutual Wealth, welcomes a full consultation on the future of pensions’ tax relief. “The Green paper on strengthening incentives to save is a once in a lifetime opportunity to develop a regime that helps return Britain to a nation of savers, not spenders.  Pension contribution rates are the biggest factor in generating retirement income, therefore the consultation is arguably more significant than any of the reforms we have seen in the last year.”
 
 He continues: “It is disappointing, however, that the Government has decided to pursue plans to curb pension tax relief for high earners. The Chancellor has raided the pension tax relief piggy bank to pay for a manifesto pledge but this persistent tinkering is not helpful for consumer confidence.  The pension landscape has changed massively over the past year and further tweaks around the edges of legislation just puts people off pensions. This is contradictory to the impact the Government hopes to achieve with its Green paper on pensions tax relief. While these interim changes are not due to come into force until April 2016, it is imperative that savers, particularly high earners, continue to contribute as much as they can to their pension, rather than being put off by what they may see as more uncertainty in the pensions market.”
 
The lowering of the Pension Wise eligibility to age 50 plus raised comment from Jon Greer, pensions technical specialist, Old Mutual Wealth, who says: “New research suggests that only 1 per cent of people who are aware of the pension changes have spoken to Pension Wise as a result, so capacity is clearly not an issue.  As far as guidance or advice surrounding your pension provision goes, it is never too early to start, so extending the age criteria for consulting Pension Wise is an excellent move. This could mean more people making informed choices, or at the very least being less surprised by, for instance, the tax treatment of their chosen withdrawal method.”
 

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