Will Britain face higher tax and interest rates any time soon?

LaToya Harding
·6-min read
Britain's Chancellor of the Exchequer Rishi Sunak takes part in an outside broadcast interview, in London, Britain, November 26, 2020. REUTERS/Toby Melville
Last week, chancellor Rishi Sunak announced £4bn ($5.4bn) in new grants to support retail, hospitality and leisure firms, and another £594m for struggling firms in other sectors. Photo: REUTERS/Toby Melville

The coronavirus pandemic ravaged the UK economy last year, with industries shutting down for months at a time, businesses falling into administration and record unemployment numbers.

Government support was at an all-time high in a bid to tackle the economic downturn, and as a new COVID strain spreads throughout the country this year, further financial support measures have already been unveiled.

Last week, chancellor Rishi Sunak announced £4bn ($5.4bn) in new grants to support retail, hospitality and leisure firms, and another £594m for struggling firms in other sectors.

The chancellor said firms forced to close would receive one-off grants worth up to £9,000 per site. Other hard-hit firms will be able to apply for a funding pot from local authorities.

The package overall is expected to support more than 600,000 firms, and is provided on a per-property basis.

As the UK economy faces a double dip recession in the first quarter of 2021 thanks to a third national lockdown, the government is likely to borrow more than £394bn this year to continue to plug the gap and keep the economy afloat. This is more than double the £158bn deficit in the peak year of the financial crisis.

However, borrowing at such unprecedented levels cannot go on forever, and the government has two key options to consider to bolster the UK economy — interest rates and taxes.

Although hiking taxes is unpopular with consumers, it is vital to help support the UK economy. Raising taxes enables higher levels of government spending, but also means that people will have less money to spend and risks slowing the economy further.

Interest rates determine the cost of borrowing, and maintain economic growth and inflation at a stable rate, helping savers and pensions when increased.

The lower the interest rate, the more people are willing to borrow money to make big purchases. It gives them more money to spend, which can create a ripple effect throughout the economy.

By the end of the Napoleonic Wars, the UK’s debt stood at around 200% of GDP, and was paid off by higher taxes and less government spending.

After the First World War, the UK’s GDP once again stood at 200%, and was paid off using policies to reduce government spending or higher taxes. WW2 was largely paid off by letting inflation rise.

Watch: Rishi Sunak outlines new financial support measures

Yesterday, Sunak warned that a rise in interest rates could send the cost of paying down debt skyrocketing, despite calls to continue public borrowing without restraint.

Sunak said that although low interest rates gave the Treasury more flexibility to invest in long-term growth and productivity, he had a duty to manage the public finances in a way that was “sustainable over time.”

The Bank of England cut interest rates to a record low of 0.1% last year to cushion the initial economic blow from the COVID-19 pandemic.

Sunak told CityAm’s The City View podcast, that government borrowing must be held in check as record low interest rates were not fully understood.

“We should have some humility about saying what we think will happen,” Sunak said.

Last week stockbroker AJ Bell (AJB.L) said that markets were already pricing in a 50% chance of an interest rate cut this year.

The central bank has resisted cutting rates further but said it is preparing the groundwork for negative interest rates.

British banks are scrambling to prepare for negative interest rates, with senior leaders warning it could take up to 18 months to ready systems. Executives at British banks told MPs in November they were not yet ready for negative rates despite the Bank of England suggesting it could deploy them in early 2021.

The next Bank of England policy meeting is at the beginning of February. Laith Khalaf, a financial analyst at AJ Bell, said Monetary Policy Committee members would “have time to take a deep breath and see how the next few weeks go.”

READ MORE: Bank of England says UK banks can withstand COVID-19 and Brexit

The finance minister is also expected to delay plans for tax rises in his March budget.

A senior government source told the Times on the weekend that it was the “wrong time” for tax rises and that they were likely to be shelved until the autumn at the earliest.

“We’ll be in the midst of a recession and living under severe lockdown restrictions,” the source said. “The mutant strain of the virus has changed our entire perspective on this. It’s too soon.”

The Treasury has made plans for an array of potential tax rises including cutting pensions tax relief for high earners, increasing capital gains tax and introducing a digital sales tax for online retailers.

In November last year, the Office for Tax Simplification (OTS) recommended equalising capital gains tax rates with those that apply to income tax. The government-run body says the tax, levied at 10% for basic-rate taxpayers and 20% for higher-rate taxpayers, could be doubled if it were brought in line with income tax.

Rather than increasing taxes of the general population, income tax and VAT, the government could instead use methods to target wealthy. Taxing millionaire households 1% above the £500,000 threshold could raise £260bn in five years, almost enough to cover the current amassed debt.

Vast swathes of the UK economy are facing at least seven weeks of severely limited trade, with many firms forced to shut up shop altogether. Cabinet minister Michael Gove said the restrictions could last into March.

Due to this, the Federation of Small Businesses (FSB) warned that more than a quarter of a million UK small businesses are set to collapse over the next 12 months.

The FSB’s quarterly Small Business Index (SBI) shows business confidence at the second lowest ebb in the report’s ten-year history, the lowest point was recorded in March 2020.

The UK SBI confidence measure stands at -49.3, down 27 points year-on-year. The majority of those surveyed (80%) do not expect their performance to improve in the next quarter.

Of the 1,400 respondents, 23% have cut their headcount over the last three months. This is up from 13% at the beginning of 2020. One in seven (14%) say they’ll be forced to cut numbers in the next quarter.

According to the Department for Business, Energy and Industrial Strategy (BEIS) around 16.8 million people work in UK small firms.

Watch: Will the COVID crisis lead to higher taxes?