ECONOMY ANALYSIS - What's Ken Clarke got up his sleeve?

Will Chancellor Kenneth Clarke cut taxes when he stands up on 26 November?

Or does the fact that the UK still has a budget deficit that looks large to many mean that he will exercise restraint and keep taxes as they are – or even raise them?

This is of course the “Budget judgement”. But it is not really only an economic one. One has to bear in mind that Clarke is also a politician, and that many in the Conservative party see a suitable Budget as the best way to continue the erosion of Labour’s lead in the opinion polls, and set them on the path to victory in the next General Election.

Although Clarke is a politician, he is showing himself to be a responsible Chancellor – thus major tax cuts in November are not on the cards. The money isn’t there. But there is space for a few modest cuts.

Opinion seems to be hardening that there is some money that can be “given away” in tax cuts. Figures of about #3bn are bandied about – a relatively small amount in the context of government expenditure, which is in the order of #300bn. Whatever figure Clarke has pencilled on his packet of cigars won’t come from surplus revenues though.

He is wrestling with some shortfalls in revenues, notably the alleged u6bn “hole” in VAT revenues. But he also has low inflation and reasonable growth on his side, with falling unemployment and of course low interest rates. So perhaps there is some spare cash there – #3bn would not be unreasonable, but it will have to come from tightening the spending side.

So what will he do with the possible #3bn of cuts?

The obvious target is income tax. That is where the Chancellor’s firepower is expected – and where of course the Tories have a commitment to work towards a basic tax rate of 20%. #3bn does not buy a 4% cut in basic rate, but it could buy a 1.5% cut to 22.5%. Such a cut helps everyone – although it helps the better off more than the lower paid.

There are other ways of cutting income tax: an expansion in the current #3,900 20% lower rate band would help the less well-off, as would an above-inflation increase in the #3,765 personal allowance. Possibly there will be a combination of all of these – a cut of the basic rate to 23% (with a promise of more to come?), plus adjustments to bands and allowances.

Do watch the level at which the 40% tax rate kicks in: currently this is #25,500 of taxable income. Leaving this unaltered would be a subtle way of raising more tax as rising salaries will pull more income into the higher tax bands.

Assuming the Chancellor has a few pounds left after income tax cuts, he is bound to look at Capital Gains Tax and Inheritance Tax. We have heard comments that the Conservatives would like to abolish both taxes.

Neither raises much. But any outright abolition this time is unlikely.

CGT must stay in some shape or form anyway – it is in essence anti-avoidance as it stops people avoiding tax by realising gains. Conceivably IHT could go, to be replaced by CGT on death, which could even raise money.

More likely is another substantial rise in the IHT threshold – perhaps another #50,000 to #250,000, to try and make further moves towards Mr & Mrs Average in the South East getting their combined estate outside the IHT net. After all, these Average people are often those who are worried about the impact of the tax on what they see as their nest egg for their children – and, dare one say it, they may be Tory voters.

After so much talk of tax, you may feel like a drink. Will that cost more after the Budget? There are commitments to raise petrol and tobacco duties more than inflation. The alcohol duties are less clear: there are well publicised differences with European levels of duty to take into account. Probably any rises in duty will be restricted to beer and wine, with spirits escaping – the current system bears more heavily on the drinks with a higher level of alcohol. Or even a cut in duty on Scotch and the like?

Somewhere there will be a couple of “attention grabbers” as well. Some form of tax relief for those who care for elderly relatives at home would be popular – and would be consistent with “care in the community”. Finally, going back to alcohol for a moment, how about higher duties on “alcopops”?

John Whiting is tax partner at Price Waterhouse.