Tax Rises, Pensions and Property: What to Watch in the UK Budget

• What tax changes could be in store and why do they matter?
• We answer your questions about what it means for your money

What might be coming up in next week’s UK budget and what could it mean for your money?

In a live Q&A on the Markets Today blog, we we put your questions to senior economy reporter Phil Aldrick and personal finance expert John Stepek.

Here is a lightly edited transcript of the conversation, covering topics from income tax to inheritance tax, pensions to housing, ISAs, banks and businesses. And of course, the market, economic and political significance of it all.

And for the latest on everything that matters to UK investors, check out Markets Today.

We’ve heard Reeves isn’t going to increase income tax, but that she’ll freeze income tax bands. What does this mean and how does it affect earners?

Phil Aldrick:

Perhaps the least painful way Reeves has to raise tax, politically, is to freeze income tax and National Insurance thresholds for two more years — in 2028 and 2029 — rather than raise them in line with inflation.

What that means is more of a worker’s pay is subject to tax above each of the 20%, 40% and 45% bands. For Reeves, the policy generates a lot of money but is not an increase in the tax rate, so does not break Labour’s manifesto pledge.

For households, the freeze is in the future so there is no pain today. Estimates of how much the chancellor will gather range from £7.5 billion to £10 billion, depending on the Office for Budget Responsibility’s estimate of wage growth at the budget.

Although less immediately painful, the “stealth tax” has huge social ramifications. Thresholds were first frozen by Rishi Sunak, as Tory Chancellor, in 2021 and have since been extended to 2027-28. Even before this budget, the result is that 3.2 million more people will have been pulled into higher rates of tax, raising more than £30 billion a year.

As the Institute for Fiscal Studies says: “These real-terms threshold reductions represent one of the most significant changes to the personal tax system in recent decades — fundamentally reshaping who pays tax and at what rates.”

What’s the fiscal buffer everyone keeps talking about and why does it matter?

Phil Aldrick:

First a definition. The fiscal buffer, or headroom, is the extra money Reeves sets aside after meeting her fiscal rules. The idea being that the larger the buffer is, the more shocks she can withstand without having to tear up her plans and come back for more tax rises or spending cuts.

It is effectively insurance against bad things happening, and the more insurance she has, the more confident the markets are that her plans will hold. That’s important for businesses and households, allowing them to plan financially with confidence, and for bond markets that want to know the national debt is under control.

If the government keeps coming back for more borrowing, Reeves’ fiscal pledges will look pretty threadbare and the cost of debt will rise. So how much headroom will she have. At the moment, it’s £9.9 billion and the third smallest on record. She has made it clear that the headroom will rise.

The bond vigilantes are looking for £20 billion, still below the average since 2010 of around £30 billion, but Reeves may get away with something just above £15 billion.

Why should we pay attention to the gilt market after the budget?

John Stepek:

Even if the measures pass muster on the day, the big test will be in the days following the budget. Can she make her plans stick? Will her backbenchers put up with it? Will the electorate? Will talk of deposing Keir Starmer die down or pick up?

In many ways the politics of this budget are even messier than those of the Liz Truss/Kwasi Kwarteng episode in 2022.

The inevitable endgame in that case became clear extremely rapidly, whereas the potential scenarios for Starmer and Reeves are wider ranging, at least for now, which implies that political sensitivity will remain an issue for both gilts and sterling for many months to come.

What could cause a big move in stocks on the day?

John Stepek:

I think a banking tax is one of the biggest “on-the-day” risks for investors. Financials have been a major contributor to the rally in UK stocks (and Europe in general for that matter) this year.

Part of the driver behind that has been a more bank-friendly interest-rate environment, but another driver has been the sense the banks are finally being allowed to get up from the naughty step and become useful corporate members of society again.

A banking tax would be a major step backwards in that sense of rehabilitation.

So is a tax on banks likely?

Phil Aldrick:

An increase in bank taxes is less likely than it might be for some other sectors.

Reeves is alert to the role the financial sector plays in delivering growth and is reluctant to target the cash cow that is the City. She has been deregulating, pushing for supervisors to reduce some of the rules erected since the financial crisis.

Having infuriated business with last year’s NICs rise, the banks have been the one part of the private sector that remains supportive.

But she may decide she needs the money, and there is a case to tax the windfall gains being made from high interest rates.

Former Prime Minister Margaret Thatcher did just that in the early 1980s, after all. A number of think tanks have promoted the idea and Reform, the Liberal Democrats and the Greens are all endorsing a bank tax in some guise. Reeves could raise anything from £2 billion to £6 billion. It could be a big moment if she does this.

How might the government change council tax?

John Stepek:

The UK’s council tax bands haven’t been updated since 1991. This is a problem that is both widely recognised and widely ignored because updating it them would be time consuming and open up whole new cans of worms.

However, as Bloomberg Opinion writer Matthew Brooker noted earlier this month, one idea potentially being mulled by the Chancellor as a sort-of substitute “mansion tax” is to significantly increase (perhaps by 100%) council tax on the top two bands, G and H.

On the face of it, this is a tempting move as it would lob a “wealth tax” story to the left of the Labour party, as well as raising more than £4 billion (according to the Institute for Fiscal Studies think tank - who do not advocate the approach, to be clear). However, it’s also ripe for a “pasty tax” style backlash.

One issue with the 1991 valuations is the inconsistency. Many houses that fall into band G in one council area may be worth less than those in other areas with far higher values. These people will likely rebel as they find that not only has their council tax doubled, but that their ownership of a relatively “normal” house now puts them alongside Mayfair penthouse dwellers as having the “broadest” shoulders.

Anyway, if it does happen, then it’s possible to challenge the banding of your home but even that isn’t a guarantee of success. Worse still, there’s also the risk of it backfiring with your council might deciding/ruling instead that you should go up a band rather than down one. If this does go through I can see a lot more councils seeing a lot more challenges.

One of the areas Reeves is reportedly looking at is limiting salary sacrifices. How will that affect pensions?

John Stepek:

Salary sacrifice is a useful way to make contributions to your pension from your gross salary. In doing so, you not only get the income tax relief you would get from making a pension contribution from your net salary, but you also avoid paying National Insurance (at 8% or 2%, depending on your earnings).

More significantly, so does your employer (at a whopping 15%), and many use that tax saving to boost their employee’s contributions. Reeves is said to be considering capping the amount that can be paid into a pension in this way at £2,000 per tax year. This would raise about £2 billion in tax but it’d be bad news for employees, and it would be worse for employers.

Let’s say you earn £125,000 a year. You put £25,000 into your pension in order to avoid the 62% marginal tax rate that kicks in after £100k. (You start losing your tax free allowance of £12,570 at a rate of £1 for every £2 of adjusted net income over that threshold). If salary sacrifice is capped at £2,000, you’ll now be charged NI at 2% on £23,000. So that’s £460 less that ends up in your pension, which adds up over time, in much the same way as overly high management fees corrode your long-term returns.

But arguably more significantly, your employer will be charged 15% on the £23,000 which is an extra £3,450 in payroll taxes that they have to shell out. That cost has to be recouped somewhere — perhaps from your future pay rise, or maybe the generosity of the pension scheme for future employees. In effect — and this is the one thing that might put Reeves off the measure — it’s another increase in employer NI, which would be a slap in the face for the private sector after last year’s huge employer NI hike.

Bottom line: any changes to pensions, risks reducing the amount saved for retirement. And that surely stores up a host of future problems for both individuals and potentially the state.

Is there going to be a tax on gambling?

Phil Aldrick:

In a budget where Reeves is looking for easy targets, gambling companies and banks seem easy pickings. Neither are popular. Online betting and fixed odds betting terminals, slot machines or “one-armed bandits,” are almost certain to see an increase in the duties already paid.

Former Prime Minister Gordon Brown has been calling for it, as have campaigners who are concerned about gambling addiction. Reeves appears to have decided to target websites rather than bookies on the high street, with existing 21% rates going up for online games betting.

Bookies are likely to see an increase in the 20% levy paid on slot machines. It may raise £1 billion.

How is AI impacting the job market and the country’s fiscal situation, and is that something politicians can tackle?

Phil Aldrick:

AI is simultaneously good and bad. For young people, artificial intelligence appears to be a threat by replacing entry-level jobs.

Professional service firms are increasingly using AI to do jobs that graduate recruits might have. Klarna, the buy-now, pay-later firm claims to have halved staff with the help of automation, yet also talks of pay rises for those who survive.

The employment data tells a worrying story, too. The number of 16-24 year olds not in education, employment or training (NEETs) has risen to almost a million, and the unemployment rate for the group has risen to 15.3% from 14.8% last year.

But AI, as Bank of England Governor Andrew Bailey has repeatedly said, offers us genuine hope of a productivity boost that spares the UK another decade in the doldrums and delivers higher living standards for all.

Will business tax rates rise? Which sectors are most at risk?

Phil Aldrick:

Smaller businesses are already on course to lose tax relief in April, which will effectively increase their business rates by £1.7 billion on top of any further changes.

The Treasury is alert to their concerns, as well as those of the wider high street and will try to rebalance business rates.

The government wants to reinvigorate high streets, which pay higher rates purely because the property is worth more. It is already shifting more of the burden to out of town warehouses, with online retailers being targeted. Supermarkets with large hubs have also expressed concerns that they could be caught by this effect as well.

What should I do to protect myself ahead of potential changes in the budget?

John Stepek:

Plenty of wealthy people have been making significant changes to their personal financial arrangements ahead of the budget, as this investigation from my colleagues Ben Stupples and Mark Harlow highlights.

Others have pulled their tax-free lump sums from their pensions for fear that Reeves would cap it in some way, although this now looks to be one of the few areas that has been ruled out, this time around, which highlights the dangers of reacting to speculation (and for any politicians reading, the danger of creating an environment in which such speculation can run rampant).

But overall, there’s simply not that much you can do, except make sure that you are on top of your own financial situation, (a qualified financial adviser can help you understand your options) so that you’re in a position to react once you know how the land lies. I ran through some basics in Money Distilled earlier this month.

How might ISAs change and what would I need to do?

John Stepek:

When it comes to ISAs (the UK’s tax-efficient savings schemes), there has been plenty of pre-budget speculation that the Chancellor might limit the amount that can be saved in cash, rather than other investments, each year.

At the moment, you can put the entire £20,000 annual allowance into cash every year if you wish. The concern is that some UK households are “oversaving” and ending up with poorer returns than if they had invested their long-term savings in stocks instead. There is also a wider drive to encourage more “idle” money into UK assets. So reducing the amount that can be put into cash each year to say £10,000 may seem tempting.

There are arguments that this would send a valuable signal to investors that Britain is taking the plight of its domestic stock market seriously. There is also merit to the idea that the UK has an unhelpfully skewed attitude towards risk — we emphasise the possibility of nominal losses when buying stocks, but don’t balance that with warnings about weak “real” returns from holding money in cash.

Equally though, many savers hate the idea of being “forced” out of cash. Building societies have also pushed back hard, arguing that it would crimp the supply of mortgages. And as data from investment platform Hargreaves Lansdown shows, those UK retail investors who do venture into stocks, already tend to be overweight the UK — “across HL’s 2 million clients, the UK is by far the most popular investment region, accounting for 35% of the entire platform”, according to Emma Wall, HL chief investment strategist.

So will Reeves deem it worth the hassle, for no overt fiscal gain? We’ll see. Meanwhile, if you’re worried about it, the simple solution is to make sure you’ve already filled your ISA for this year.

What changes could be in store for inheritance tax? Could the seven-year giving rule change and what would the economic implications be?

John Stepek:

Inheritance tax is one of the most hated taxes in the UK, but it’s an increasingly lucrative tax for the government. The inheritance tax take hit £8.2 billion last year, a record.

It’s also a wealth tax, so there is certainly a risk that the Chancellor will look again, even after last year’s reforms that hit farmers and small businesses. So what might she do?

One rumour is that she might look at the gifting rules. As things stand, if you make a gift of any size, and then live for seven years, the gift falls out of your estate for IHT purposes. Also, after three years, taper relief starts to kick in, reducing the IHT liability.

The Chancellor could look at extending this period to 10 years, or getting rid of taper relief, or both, or even imposing a lifetime cap on the total value of gifts that can be IHT-exempt.

This would be great news for the UK’s army of tax advisors, who will garner some extra billing hours as legacy plans would have to be scrapped and redrawn across the country.

The behavioural changes are trickier to predict. Extending the lifetime gift cap might accelerate some gift-giving plans, and trap some estates that would otherwise have avoided IHT. But equally, as we’ve already seen with at least some non-doms, the tighter the IHT net is drawn, the greater the incentive to simply up and leave the UK.

An alternative to revisiting IHT directly might be to change the capital gains tax (CGT) rules. At the moment, if you pass on an asset after you die, there is no CGT to pay, regardless of the level of appreciation during your lifetime. Your heir inherits the asset at the current price, effectively re-setting the capital gains clock to zero.

The government could change this and charge CGT on death. This feels like one to watch out for, given its relatively stealthy nature.

What could the budget mean for Rachel Reeves’s legacy, and her future as chancellor, and what might the political fallout be?

Phil Aldrick:

This budget is a huge moment for Reeves, a third — and possibly final — chance to prove she can handle the delicate balancing act that a budget really is. The last two have not landed well.

The first, the biggest tax raising event since 1993, infuriated firms that had taken Labour’s pre-election pitch to be the party of business at face value. The £26 billion payroll tax was seen as a betrayal, and the market did not like the big increase in borrowing that came alongside it.

Having upset the private sector, she then disappointed her own party with welfare cuts as she scrambled to recover her headroom in March after a market-driven increase in borrowing costs. The u-turn three months later revealed that the leadership does not have the backing of MPs and the backbenchers may even be steering the ship.

Now, having promised not to repeat the big tax rises of last year, there will be a lot more. Can she please all constituencies — the markets, the public, business and her own MPs? Almost certainly not.

She will give backbenchers something to sell on the doorstep by scrapping the two child benefit cap and thereby reducing child poverty. Markets may get the increased headroom they want, as well as a welcome attempt to push down inflation and free the Bank of England to cut rates. But the wider tax rises will inevitably upset many, particularly the wealthy with “the broadest shoulders.”

The laundry list of those small tax measures may unravel under pressure from protest groups on her own side, and the handling of the budget build-up has been shambolic. With Keir Starmer facing a potential leadership challenge, and Reeves tied to his survival, this may be a make-or-break moment.

If she pulls off a budget that succeeds with both the markets and her MPs, does not unravel in the subsequent weeks and finally establishes the “economic stability” promised, it may be the first of Labour’s many “resets” that actually works. It won’t be easy.