HAMISH MCRAE: Chancellor's getting a message from the Seventies

Economic Challenges Mount Ahead of Spring Statement

This week is anticipated to be challenging. Chancellor Rachel Reeves is expected to acknowledge in the upcoming Spring Statement that the fiscal strategy outlined in last October’s Budget, concerning taxation and public expenditure, has deviated from its intended course.

The economic climate is also poised to face headwinds as companies prepare for scheduled increases in National Insurance Contributions. Furthermore, households will confront the pressures of escalating inflation and a tax burden approaching levels not seen since the late 1940s.

The prevailing economic atmosphere increasingly evokes parallels with the 1970s, a period marked by significant economic adversity.

Budgetary Pressures Intensify

The factors contributing to this situation are understood, with further details expected from the Office for Budget Responsibility on Wednesday.

Economic growth has weakened considerably, while government borrowing has surged. In the initial eleven months of the fiscal year, government borrowing reached £132 billion, exceeding projections from last October by £20 billion. This discrepancy is partly attributable to increased public spending, including debt servicing costs. However, a primary factor for the Chancellor is the shortfall in tax revenues, which are currently underperforming forecasts. While immediate tax increases are not anticipated this week, further taxation measures are expected in the autumn Budget.

Drawing Lessons from the 1970s

Considering the current economic trajectory, historical precedents offer potential insights. The 1970s provide a relevant case study in managing fiscal strain. During that period, government intervention to rectify public finances was prompted by the necessity of seeking financial assistance from the International Monetary Fund (IMF) in 1976.

While an IMF intervention is not anticipated presently, financial markets are expected to exert similar disciplinary pressures.

The UK’s 10-year gilt yield, currently at 4.7 per cent, is the highest among G7 nations. Compounding this, a significant portion of the national debt is index-linked, heightening vulnerability to inflationary pressures. Concerns regarding the escalating debt burden are reportedly prominent for the Chancellor, a sentiment that is considered well-founded.

Addressing public sector productivity, which remains below 1997 levels, is recognized as a long-term imperative. However, immediate strategies must address the prevailing economic realities.

Strategies for Navigating Economic Uncertainty

The economic challenges of the 1970s prompted specific strategies. Two key approaches emerged:

Minimizing Income Tax Liabilities

A primary strategy was to minimize income tax obligations. In the late 1970s, with top marginal tax rates on earned income reaching 83 per cent, companies explored various means to compensate senior employees. These included:

• Generous entertainment allowances
• Company vehicles with complimentary fuel
• International assignments for personnel

While current income tax rates are lower, adjustments such as making personal pension pots subject to inheritance tax (IHT) could elevate the overall tax burden in certain contexts. For many individuals, maximizing pension contributions remains a key method for managing income tax, despite recent tax policy changes. It is anticipated that employers will need to develop further incentives to attract and retain talent.

Alternative strategies include establishing businesses to accumulate savings, or for some, relocating to lower-tax jurisdictions, at least temporarily, to mitigate income tax and capital gains tax liabilities.

Protecting Savings Against Inflation

The second key rule was safeguarding savings from inflationary erosion. This involved investing in assets expected to appreciate in real value, notably:

• Property
• Equities

Homeownership in the 1970s proved to be a highly effective investment, with property values generally outpacing inflation. For example, the average property price in 1975 (£8,500) equates to approximately £65,000 in today’s terms, considerably less than the current average of £270,000.

Equities have also demonstrated substantial real returns, averaging around five per cent annually. The introduction of Individual Savings Accounts (ISAs), which were not available in the 1970s, provides a significant advantage by offering tax exemptions on capital gains and dividends, making equities a potentially more advantageous long-term investment compared to cash.

Key Takeaways

The overarching message from the 1970s remains relevant: Governments face challenges, economies stagnate, and inflationary pressures intensify. However, strategic approaches to wealth building and preservation persist for those who maintain a measured perspective.

In the current economic climate, minimizing tax liabilities and investing in assets resistant to inflation are crucial considerations. While not straightforward, these measures are essential for navigating economic uncertainty.