How to cut taxes whilst raking in more money

Tony Blair was always seen as the master of spin, but it seems the man set to be our next prime minister could be just as slippery. John Stepek takes a look at what's going on behind those '2p off income tax' headlines.

This feature is part of our FREE daily Money Morning email. If you'd like to sign up, please click here: sign up for Money Morning


After 10 years of stealth taxes, U-turns and nasty surprises in the small print, you'd think that Gordon Brown - or Uncle Gordon, as he shall forever be known after his colleagues' 'Stalin' jibes - would have lost his capacity to surprise with his cynicism.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Tony Blair was always seen as the master of spin, but the Chancellor's final Budget shows that if anything, the man who's likely to be our next - unelected - Prime Minister is even more slippery.

What do we mean? Well, let's have a look at what's going on behind those '2p off income tax' headlines...

The Chancellor left the best until last with his closing announcement in the Budget that he'd knock the 22% income tax rate down to 20%. But as always, things are not quite what they seem.

The cut - which comes into effect from April 2008 - will cost £8bn. But he's scrapping the 10% starting rate of income tax, which covers around the first £2,150 earned after personal allowances. So people will start paying the 20% rate sooner. In other words, the less money you earn, the more likely you are to be paying more income tax.

So he's grabbed a few headlines by spending £700m and taking more money from low earners. Oh, except, actually, it won't even cost him £700m. Because National Insurance Contributions (NICs) - you know, those things that Governments say are contributing to your state pension, but are in fact just another income tax - are being 'realigned' with income tax bands, so that people earning up to £43,000 a year will pay 11% NICs. This will earn the Treasury another £1.5bn by 2009.

But of course, it takes time to work all that out, which means that Uncle Gordon got to score a few political points by wrong-footing the Tories who haven't had the guts to commit to any significant tax cuts as yet.

What about big business? They must be cheering that 2% cut in the coporate tax rate, right? Well, as Professor Peter Spencer of the Ernst & Young ITEM Club said: 'It is a con trick, no doubt about it. I will be amazed if people are duped by it for more than five minutes.'

As The Telegraph points out, companies will pay £1.4bn less in corporation tax in the 2008/09 tax year, but changes to capital allowances will free up £1.5bn in the same year - another headline grabber, and yet another net profit for the Chancellor. And of course, it was just bad news for small companies, who'll see their corporate tax rate rise from 19% currently, to 22%. Oh yeah, and the companies that explore in the North Sea still pay 50% - no cut for them, even though we need all the energy we can lay our hands on.

So what else did he do? The Isa rate finally moved upwards - from April 2008, you will be able save a whole extra £200 a year tax-free (well, tax-efficiently, at least), and put £3,600 of that in cash, rather than £3,000. As we've pointed out on numerous occasions, if the Isa allowance had risen in line with inflation, you'd now be able to save £8,400 - so in real terms, the Isa allowance is still way below what it was in 1999.

He's also stood by his beloved tax credits system. If anything sums up why the Chancellor shouldn't be allowed to run an egg and spoon race, let alone an economy, it's the tax credits system.

This arcane shambles, which has been roundly criticised by nearly all involved save Uncle Gordon, is incomprehensible to its recipients, and barely understood by its administrators. It has resulted in idiocies like low income families paying a marginal tax rate of 70% once their earnings reach a certain level (around £7,500).

Not much of an incentive to get back to work - and it'll be even worse from 2008, because once the 10% basic income tax rate is removed, and due to other changes in tax credits, families start paying the marginal 70% rate at an even lower level of income - around £6,500.

So overall, it was the usual mendacious conjuring trick that we've come to expect from the Chancellor only even more chock-full of lies and half-truths than usual.

One of the reasons we've got the biggest tax law bible in the world, apart from India, is that the Chancellor generates all that paperwork effectively so that he can hide his tax rises from the electorate. All that bureaucracy, so that one man can put on a good show for one day, and attempt to pull the wool over the public's eyes while the press, the pundits and the financial industry scrabble to keep up with all the small print and exceptions.

No salesman would be allowed to get away with it why do we tolerate it in our politicians? We don't have the answer but we do suspect that when the economic climate becomes less forgiving, it'll be a lot harder for the Chancellor's successor to pull the same tricks that he has for the past eleven Budgets.

Turning to the stock markets...

Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email.

London stocks ended yesterday in positive territory as investors pondered the implications of the Budget. The blue-chip FTSE 100 index closed 36 points higher at 6,256 with the broader indices also firmer. Property stock Hammerson topped the FTSE leaderboard on news that it is a possible bid target. Peers Liberty, Land Securities and British Land were also higher. For a full market report, see: London market close.

On the Continent, the CAC-40 closed just one point lower, at 5,502, in Paris. Over in Frankfurt, the DAX-30 gained 11 points to end the day at 6,712 as BMW led the automotive sector higher.

On Wall Street, US stocks rallied yesterday as the Federal Reserve kept interest rates on hold. The Dow Jones jumped 159 points to a close of 12,447. The Nasdaq was 47 points higher, at 2,455, whilst the S&P 500 closed 24 points higher, at 1,435.

In Asia, the Japanese Nikkei hit a three-week high of 17,489 in intra-day trading, going on to close 236 points higher, at 17,419.

The price of a barrel of crude oil was over 1% higher this morning, at $60.22. Brent spot was also higher, at $60.94.

Spot gold soared to its highest level in nearly three weeks - $664.60 - in Asia trading, but was slightly lower at $663.40 this morning. Silver, meanwhile, had risen to $13.34.

And in London this morning, insurer Standard Life announced plans to reduce its UK workforce by 12% in order to create a 'leaner and fitter' company and achieve savings of £100m a year by 2009. Shares in Standard Life had climbed by as much as 0.7% in early trading. In other news, retailer Next announced a 5.7% rise in annual profit as web and catalogue sales made up for a drop in revenue from its high street stores. The company's stock was up by as much as 2.8% this morning.

And our two recommended articles for today...

What US housing collapse means for Asian markets

- The Asian stock market panic may be starting to look a little overdone, but that's not to say there isn't more fallout to come from the bursting of the US property bubble, says Philip Bowring of the Asia Sentinel. If you want to know more about the current state of the region's markets and which are looking the most vulnerable, read: What US housing collapse means for Asian markets

When interest rate hikes aren't enough...

- When it comes to credit, it seems that there are no lending criteria too lax, no products too outlandish and no multiples too high for the financial services sector to consider. And all of this innovation means that central banks' failsafe anti-inflation measure no longer works. To find out what Adrian Ash thinks could bring about the top of this credit cycle, click here: When interest rate hikes aren't enough...

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.