How have expectations of the economic impact of the pandemic changed over time?

In the early weeks of the Coronavirus (COVID-19) outbreak the assumption was that the economic impact would be a sharp recession, with a massive drop in output for a short period, and then a quick return to normal as the pandemic was controlled. Some industries might suffer lasting damage, but (the thinking went) there would probably also be a mini-boom as pent-up demand for goods and leisure activities was released. The world would largely continue as it was previously, with increased public debt levels in most countries as a result of paying for economic shutdown measures, and a one-year reduction in GDP and tax revenues.

It’s increasingly clear that this assumption was wrong. Even in those countries that have had relatively small outbreaks with few cases and deaths, moving out of lockdown is a long and careful process, with no end in sight to social distancing measures. For sectors of the economy that rely on jobs that cannot be carried out from home—and of course for leisure, tourism, and hospitality—any recovery looks slow and painful, with reduced profitability due to ongoing restrictions on the number of people who can now be fitted into any given building at the same time. The UK’s extension of its furlough scheme to October shows an increasing realisation that there will be no quick bounceback to the world as it was before.

How has the UK government been reacting in the short term?

In the short term, the government is rightly focused on immediate support measures including protecting employment, minimising the damage to the economy and ensuring liquidity to minimise insolvencies. This means that there has been very little meaningful discussion of the tax and spending choices that may need to be made in future. Most official comments have suggested that there will be no return to austerity and that there is not much appetite for tax rises. However, at some stage, the economy will move from stabilisation to recovery. Indications are now that this will be a slow, painful process, with consumers reluctant to spend, fewer enterprises remaining in business, and continued restrictions on many sectors limiting economic activity.

How might the government approach tax policy in the future?

The challenge for government will be to restore growth and support business activity rather than worry about immediately bringing the public finances back into balance. It’s likely that traditional tax stimulus measures will be used. However, this will depend upon the economic nature of the recovery that the government wishes to promote. If the aim is to stimulate consumer spending then personal taxation and VAT would be cut to boost discretionary spending as in 2009/10. If the government’s aim is to stimulate business investment and infrastructure spending then the focus will be on capital expenditure reliefs, business rates and tariff exemptions through enterprise zones and free ports, tax reliefs for investing in tech start-ups and R&D and other innovation reliefs. This was the approach adopted in 1983/84 and 1993/94. Given the simultaneous impact to both supply and demand, it may not be an either/or choice, but more a case of government having to pull as many levers as possible at the same time.

If businesses are in no shape to pay increased taxes, where will the money come from? Looking at the political climate, probably debt. Assuming that the UK political debate continues to be a contest between national populism and traditional centre-left economics, further austerity is off the table. The winning Conservative manifesto in the 2019 election and the follow-up 2020 Budget showed that the UK electorate is keen on a combination of low taxes and increasing public spending. Because of this, and regardless of the economic reality, it’s difficult to see the government paying an electoral price for continuing to tell voters what they want to hear in difficult times.

Other favoured taxes have (literally) run out of road: it will be hard to tax travel when not much of it is happening—hard to tax consumption when we want more of it—and hard to tax physical premises when far more commerce is happening at home and online. The issue here is how to maintain existing tax revenue. Reform of local government property taxes looks essential but both business rates and council tax are thorny issues. Recent governments have narrowed the breadth of these taxes meaning that more and more of the burden falls on fewer taxpayers. Rates assessments based on notional rents and theoretical profits looks hopelessly antiquated. Might the government look to shift to a more profit or activity related tax by reducing business rates and increasing corporation tax or a turnover related tax?

To be fair, increased debt is a rational strategy in the medium term: most major economies will be in a similar position meaning that the threat of being ‘the next Greece’ will not have the same resonance as it did a decade ago. The impact of the pandemic can be compared to a world war, and high long-term debt levels eventually dealt with via inflation have previously been accepted in such severe situations.

What types of tax increases might we see?

None of this is to say that there will be no tax increases and even relatively small tax increases could be substantial in absolute terms. Assuming no change of government, initially they are most likely to fall into two categories:

• ‘costless’ increases which are not seen to suck cash out of the economy, and
• populist dividing lines, which may have the incidental benefit of raising revenue but are mostly intended to signal that the government is on the side of ‘ordinary voters’
  

It also seems very likely that offshore holding structures will be in the firing line when UK taxpayer support has helped keep owners’ businesses going during the pandemic. Expect further anti-avoidance and transparency measures to be announced (and perhaps even implemented). Other measures impacting multinational enterprises, such as further restrictions on corporate interest deductions may also be popular. Indeed, an increase in HMRC enquiry activity is likely to be encouraged—both to try and increase the tax take and to maintain public support.

On balance it may be difficult to increase headline corporation tax rates for larger enterprises while supporting business recovery, but a balancing act which combines higher headline rates with more generous reliefs for ‘good’ businesses that are ‘helping the recovery’ could be another popular way of taxing those seen to be unduly profiteering.

For smaller businesses, there has already been plenty of discussion of the different tax treatment of the self-employed and those trading through limited company structures, many of whom have been generously supported by the government’s rescue measures. It will be difficult to argue for a beneficial tax treatment in future now that it has been seen that government underwrites the risk of the self-employed as well as the employed. As a result, Chancellor of the Exchequer, Rishi Sunak, is likely to have an easier ride than his predecessor in that role, Philip Hammond, if he dusts off measures to level the playing field between the employed, the self-employed, and those working through limited companies.

Indeed, Rishi Sunak’s first two big tax changes could be to have dramatically reduced entrepreneurs’ relief and to increase tax on the self-employed, as he has indicated. This approach may surprise some who voted Conservative last December.

Finally, on the basic principle that it’s always easier to tax those who have money, the online businesses that are likely to emerge as winners in the new world may well be expected to pay more. Windfall taxes on ‘winners’ are popular (if not always effective). It’s hard to guess exactly how far and how fast we can move toward turnover and digital services taxes, and the challenges of making these taxes work will not get any easier. In a similar vein, financial transaction taxes will continue to be discussed, and based on the evidence of the last decade may well continue to be too difficult to implement. Nevertheless the popular pressure to be seen to tax the businesses that have had a good crisis will be difficult for any government to resist.

John Endacott is a partner and head of the tax practice at PKF Francis Clark and a member of the PSL Tax consulting editorial board. John’s principal focus is on family businesses and private clients and his main area of expertise is in respect of business structuring.