Yesterday new UK chancellor Rachel Reeves delivered the Labour government’s much anticipated budget. It was the first Labour party budget since 2010, and as such is being widely seen as delineating future UK tax policy and the government’s relationship with the City of London and the investment community.
It comes as no surprise that Reeves has decided to increase capital gains tax, having been widely speculated in the run up to this week’s budget speech. There were fears that the Chancellor might have sought to align capital gains tax with income tax. However, she has opted for more modest increases, with the basic rate increasing from 10 per cent to 18 per cent and the standard rate moving from 20 per cent to 24 per cent from today.
This is probably the most significant immediate impact for UK-based traders. In making these changes, the Chancellor may have deliberately avoided the obvious ‘Halloween Horror’ headlines.
“It is likely that the government has been advised that more substantial increases would have had a disincentive effect, particularly if it led wealthy individuals to leave the UK for lower tax jurisdictions,” said Tom Minnikin at UK tax consultancy Forbes Dawson. “Ms Reeves has probably pitched it about right in preventing a mass exodus, although there will be some for whom the changes are unpalatable.”
For most UK investors with tax free ISA and SIPP allowances, there should still be plenty of room within the existing CGT-free allowances with those wrappers. For traders who find themselves using these up relatively quickly, financial spread betting providers are finding that more traders are starting to use these accounts, as they are also free of CGT and can be utilised with relatively low levels of leverage.
“Whilst today’s Budget has been less painful than many expected, it’s still not a great day for retail investors, with a heavier tax burden on those putting their money to work in the markets, essentially disincentivising investing,” said Dan Moczulski, UK Managing Director at eToro. “Compared to other countries, Brits are more likely to keep their savings in cash, yet history shows that a diverse stock portfolio comfortably outperforms cash in the long run. With interest rates falling, the government should be seizing the opportunity to incentivise investment habits which help people to grow their wealth.”
Budget documents confirm the official death of the short-lived British ISA citing mixed responses to the initial consultation. Further complication of the ISA regime would have been unwelcome, but the government missed an opportunity to simplify the regime by merging Cash and Stocks and Shares ISAs.
“This artificial division has, for too long, prevented people from thinking about their savings and investments holistically,” said Richard Parkin, Head of Retirement at fund manager BNY. “For many, a mix of cash and investments is likely to be the best approach and being able to easily combine this into a single product is hugely valuable.”
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Tax on carried interest for fund managers and family offices
There are some concerns being voiced within the fund management community about Reeves’ decision to increase capital gains tax on the performance fees that private equity fund managers make when assets are sold, known as “carried interest”, to 32%.
While the government would increase the capital gains tax rates on carried interest from April 2025, the rate is currently 28%.
Gus Morison, CEO and founder of the hedge fund and family office network AYU, said: “It’s evident from this budget that the government lacks a comprehensive understanding of the factors required to create an environment that attracts entrepreneurs and nurtures entrepreneurship. Their lack of business experience or enterprise is apparent in their actions, which is both embarrassing and concerning.”
Morison said his members, including regulated investment funds and private entrepreneurs, are telling him that the unfavourable business environment, combined with the government’s undermining of confidence in the UK and the resulting hindered growth, is making them reconsider starting and operating businesses here.
“We’ll likely follow them to financial centres that welcome them, as this situation may lead many to seriously question whether the UK remains an attractive destination for entrepreneurship,” Morison said.
What about the budget and the UK economy?
The other area where the budget will affect traders is how it impacts the underlying UK economy. This will feed through into the GBP, UK gilts and the wider UK stock market, which was in dire need of a boost going into the budget.
The government came into office promising to prioritise growth. But the reality of their first budget – heavier burdens on business and more borrowing for public sector capital spending – does not inspire much confidence in their approach.
“Coming alongside an inflation-busting increase in the minimum wage and heavy-handed changes to employment law, higher employer National Insurance Contributions will be a bitter pill for firms to swallow,” said Tom Clougherty, Executive Director at the Institute of Economic Affairs. “Businesses will see their costs rise and it will be workers who pay the price – in the form of lower wages, reduced benefits, and fewer job opportunities. The idea that this budget does not increase taxes on workers is an economic fantasy.”
The worry is that Britain’s international competitiveness and economic dynamism are facing death by a thousand cuts.
“Individually, the measures taken on Capital Gains Tax, non-doms, and stamp duty might not make headlines. But taken together, they paint a sorry picture of the way things are going,” Clougherty said. “Without a radical, reformist agenda – a focus on the fundamental causes of our economic malaise – this government faces the same fate as its immediate predecessors: getting stuck managing Britain’s relative decline, with no clear plan to break free of it.”
Market reaction to the budget was muted
As the market sifts through the many details and uncertainties of this budget, the market reaction suggests that this budget will not deliver quite the optimistic GDP outlook that the Chancellor announced, one that is far rosier than that of the Bank of England.
Instead, while the inheritance tax changes were a relief relative to what was feared, the capital gains tax hike looks a bit hefty and falling gilt yields suggest the market sees the overall tax adjustments, including the lift of employer national insurance contributions, as slightly negative for the economic growth outlook, if only at the margin.
Alternatively, the reaction is the bond market, giving the thumbs up that the budget will not excessively aggravate risks from the UK’s large ongoing deficits and heavy national debt load. Spending announcements are also significant, if less so than some felt likely.
The overall impression is of a slightly more austere budget than anticipated. Sterling is a bit weaker, but the moves in nearly everything are rather modest so far. A bigger move in the Euro/Sterling exchange rate would be needed that sustains above the important 0.8400 level if the market was to signal a more pessimistic outlook for sterling and the UK economy relative to that of Europe, with the latter already quite pessimistic.
The FTSE 100 Index climbed by around 20 points during the Chancellor’s speech as Reeves cemented Labour’s fiscal responsibility message but quickly dropped as tax plans were outlined leaving the index at a month-low of 8,154 during her speech.
However, as the Chancellor outlined investment plans and the speech came to an end, the market rallied back to around 8,200, around 20 points down from UK market close on Tuesday. The UK 10-year Gilt price has also held steady, down around 0.1%. The market appears to have ridden the wave of the budget and will now be focused on the US election and Fed meeting next week.