(Bloomberg) — When Prime Minister Keir Starmer and Chancellor of the Exchequer Rachel Reeves plotted Labour’s path to power in the UK, they banked on eye-catching moves to hike taxes on private equity and ultra-rich “non-dom” residents to fund key spending plans. Now, those promises are meeting reality.
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Reeves is reviewing how to implement both pledges because of internal Treasury analysis which says the moves could end up costing the exchequer money, rather than raising upwards of £5 billion ($6.6 billion) over the parliamentary term, according to a person familiar with her thinking, who requested anonymity discussing sensitive matters.
Having to re-evaluate two flagship tax plans is a setback for Reeves as she prepares to deliver her first budget on Oct. 30, after signaling she’ll raise taxes to fill a £22 billion fiscal hole she says the Tories left her. With costings from the Office for Budget Responsibility key to determining how much fiscal space she has for Labour’s priorities, the set-piece is seen as a make-or-break moment for the government, and the chancellor is under pressure to fix the public finances while also encouraging growth and investment.
The Treasury analysis contrasts with Labour’s pre-election costings which said an overhaul of the regime taxing non-doms, British residents whose permanent homes are deemed to be abroad, would raise £2.6 billion over five years, while closing the so-called carried interest loophole on private equity would net £560 million a year. The funds were earmarked for the National Health Service and legal aid for victims of disasters.
“They’ve realized that the response to raising any of these other taxes, which is supposed to be taxes on the wealthiest, is quite large,” said Daniel Herring, researcher for economic and fiscal policy at the Centre for Policy Studies, a think tank. “People will probably just leave. But it’s also really hard to quantify these impacts.”
Over the weekend, doubts were raised about a third policy — Labour’s plan to charge value-added tax on private school fees — after government aides confirmed an Observer story that the measure might have to be delayed beyond its planned start date in January because of administrative difficulties. But on Monday, Starmer’s spokesman, Dave Pares, told reporters “there has been no change” in the timings.
Several economists — including Jamie Rush and Dan Hanson at Bloomberg Economics — have suggested Reeves should change her fiscal rules to allow more borrowing for investment to boost growth rather than damage the economy with higher taxes.
In a paper published Tuesday, the Institute for Public Policy Research urged the chancellor to switch her debt rule to a “public sector net worth” measure that catches the value of investing alongside the debt. The rule would have PSNW increasing in five years’ time. Jim O’Neill, the former Goldman Sachs chief economist, said it was a “more comprehensive debt metric” that would bring the rules “more in line with how financial markets think about fiscal sustainability.”
Reeves’s re-think on the non-dom reforms centers around Labour’s pledge to subject assets held overseas to British inheritance tax, a plan that has sparked a furious backlash among wealthy residents and warnings of capital flight. The prospect of people leaving the UK has also caused the review of the carried interest policy. Under Labour’s original plan, carried interest — a fund managers’ portion of profits on asset sales — would be taxed at the top income tax rate of 45%, rather than the 28% capital gains rate.
Mitigating Reeves’s dilemma is that the non-dom and carried interest changes only make up a small part of the government’s overall financial plan – so the potential economic hit from her re-think is limited.
“In revenue terms, these are minor issues,” said Stuart Adam, senior economist at the Institute for Fiscal Studies. They “don’t make any significant difference to the fiscal position at the budget.”
A separate person familiar with Reeves’s thinking said that she is committed to delivering on the promises Labour made in its manifesto, but that she is going to be practical rather than ideological about how measures are implemented.
The Treasury said in a statement that the government is “committed to making the tax system fairer and raising revenue to rebuild public services.”
“That includes ending tax breaks on private schools, reforming carried interest and removing the outdated non-dom tax regime,” the Treasury said.
–With assistance from Philip Aldrick.
(Updates with IPPR research in eighth paragraph.)
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