MPs have, after being given just one day to mull and debate the new policy, have voted in favour of the government’s hike to National Insurance and the tax on dividend income – but parliament’s decision is likely to have deeper consequences.
The increases will, as reported elsewhere, result in Britain’s highest tax burden in 70 years and see graduates coming into the workplace being hit with a whopping 50% tax rate.
What’s more the dividend tax rise might lead to companies deciding to change the way they pass on returns to shareholders.
With dividends being taxed higher it could lead more investors to demand a greater proportion of returns being used on share buybacks, though the effects of these schemes are by no means a sure thing for investors.
What’s more, with the Chancellor of the Exchequer’s Budget due next month and the government spending at post-war highs, the government may only just be starting on a roll to grab more cash from investors.
“Technically [the dividend tax hike] could lead to more buybacks, if the changes in taxation mean investors prefer buybacks and potential capital gains over dividends,” says Sarah Coles, personal finance analyst at Hargreaves Lansdown.
“However, it would take investor preferences to shift and for this in turn to influence company policy. At this level, the rise in dividend taxation may not be enough to move the dial on investor preferences sufficiently.
A rise in buybacks is possible but far from guaranteed, agrees Russ Mould, head of investment at AJ Bell.
With the new dividend tax bands of 7.75%, 32.75% and 38.35% after the GBP2,000 annual allowance, with capital gains tax remaining 10% or 20% on asset disposals, he says he’s not sure the change will tilt the playing field much, especially as private investors can use tax-efficient wrappers like ISAs and SIPPs to manage the extent of any tax hit.
“If buyback activity goes go up, this could be detrimental to near-term returns for private shareholders, as they don’t tend to get chance to tender their stock in a buyback – it is quicker and cheap for the investment bank that is running the buyback to go to institutional shareholders,” Mould says.
However, he says while evidence of buybacks supporting share prices on a sustainable basis is “spotty at best”, increased buybacks have the upside of boosting shareholders’ stakes on the assets and cash flows of the companies.
“If they are indeed long-term holders of a business, where they have real confidence in its business model, strategy and competitive position, then this should really work in their favour over time.
“As to whether increased buyback activity will help share prices or stock indices, there is no evidence from the past few years’ enhanced buyback activity that this is the case.”
The timing of the dividend tax increase, coming with a forecast FTSE dividend yield of 4% for 2022 and 2023 might appear that the government is being opportune in its timing.
But coinciding with the return of company dividends in recent months after most were paused or ditched early in the coronavirus crisis, is “the timing is horrible for investors”, says Coles.
However, she does not see the current high yields as necessarily the driving force behind the change in taxation, but more the government’s desire for the increase in tax to be “seen as equitably divided among society”, rather than just the NI increase on its own, with it being a regressive tax with greater impact on young workers.
As she points out, the government has been keen to play with dividend taxation as a policy tool in recent years, changing the system significantly in 2016, and then cutting the dividend tax allowance from GBP5,000 to GBP2,000 in 2018.
Indeed this dividend tax continues the turning of tables against capital markets, which may lead some investors to worry about what else Rishi Sunak may have planned in October’s Budget.
With interest rates being held at all but zero, bond yields pressured by central bank policy and hitting fixed-income investors and savers, cuts to the annual dividend allowance and the new rises in dividend tax and corporation tax, it’s a notably different direction of travel for government policy.
“After what could be seen as 40 years of capital having things its own way, at the expense perhaps of labour, the tables may be turning,” said Mould.
“It would therefore be unwise of investors to expect the same compound returns over the next 40 years as they have had over the last 40, especially as the government’s penurious state means it will have to consider other tools to dry and dig itself out of its debt hole.”
With inflation rising, adding to the weight on fixed-income investors, and the government consulting on ‘productive finance’ since last year, the government may start to decide what is and what is not productive finance and start to decree where pensions are invested, such as ‘green’ projects, Mould suggests.
“How the returns from these projects are set, to whose benefit (the state’s or investors’) and over what time period will be telling.”
With all this in mind, this week’s tax changes mean “all bets are off” for what the Budget will bring next month, says Mould’s colleague Laura Suter, AJ Bell’s head of personal finance.
As she says, there are reports and rumours flying around that further pain could be around the corner for investors.
“It wouldn’t be a build-up to a Budget without some rumours and leaks. But one thing’s for sure, the government is still on the hunt to find ways to pay for its spending during the pandemic.”