The Chancellor takes his chances

Gordon Brown will have a couple of goodies for us but trouble is already looming on the horizon

Leading tax experts expect next week's Pre-Budget Report from the Chancellor to be a pigeon-fancier's special. He will be bringing familiar birds home to roost, with the final details of measures already trailed, and on past experience he can be relied on to set some new ones flying. But, given the huge amounts of tax Gordon Brown needs to pay for the Government's health and education spending plans, we may not be keen on the overall display.

Cynics have pointed out that, by delaying this annual exercise until mid-December, Mr Brown could slip unpopular announcements into his speech with a fair chance that they will become lost in the traditional pre-Christmas hoopla. But, thanks to a sharp surge in the economy since the summer, at least Mr Brown will have growth of more than 2 per cent to buoy tax revenues. That will save him from immediately having to unveil many Scrooge-like assaults on our pockets. But that may overlook problems looming on the horizon.

"The long-term picture is far bleaker than the Chancellor would have us believe," says Aidan O'Carroll, head of tax at the accountant Ernst & Young. "We would like to ask him if he will dare to repair the damage to the economy before it becomes a real issue in 2005, or will he follow his predecessors and wait until the damage is already done? It would be easy for Mr Brown to let the economy off lightly this time. But if there is bad news on the way, it would be better to get it over with now."

That hair-shirt view is echoed by Jeremy Peat, Royal Bank of Scotland's group chief economist. He says: "The Chancellor faces a major undershoot in tax revenues this year, as compared to forecast, and risks a major overshoot on public expenditure. Then he will have to extrapolate forward and tell us whether future revenues are likewise likely to be below present projections."

So if Mr Brown gives taxpayers a sleigh ride next week, he may merely be lulling us into a false sense of security ahead of a thorough dowsing in the Budget proper next spring. John Whiting, tax partner at PricewaterhouseCoopers, says one quirk which could give him scope for raising taxes is next month's switch from the retail prices index to the harmonised index of consumer prices as the official measure of UK inflation.

Mr Whiting says: "There are suspicions that because HICP is below its assumed 2 per cent target level, and RPI is slightly above target, there could be a bit more room for upward movements in indirect taxes without much threat to the new inflation target." This could pave the way for the long-feared hike in value-added tax from its present 17.5 per cent to 20 per cent, which would be just above the European Union average.

The two inflation measures will run alongside one another, for the Chancellor has said that the switch to HICP for the inflation target will not change the custom of using the RPI in uprating social security benefits, taxes, tax allowances and tax bands.

Last April, Mr Brown did not increase the single person's personal allowance in line with inflation. If he were to revert to indexing this allowance, individuals would be able to earn more than £4,700 in a year before they start paying income tax, compared with the present £4,615 allowance.

There are similar but more generous allowances for the over-65s. And there is then a band of income on which we pay only 10 per cent tax. This band covers £1,960 of annual income, but indexation would take it over £2,000.

The starting point for inheritance tax (IHT) is another figure which Mr Brown has been innocently linking to the RPI, a practice which should take it up from £255,000 to £263,000. The trouble is that the major element in most dead people's estate is the value of their house, and house prices have been rising more than twice as fast as the RPI in the past decade.

Cormac Marum, tax partner at the business advisory firm KPMG, says: "The rise to £263,000 will not be enough to remove the IHT worry from many elderly people and their families, who increasingly see the family home attracting IHT at 40 per cent." To catch up with the growth in house prices, the threshold would have to jump to £400,000.

An increasing number of experts believe the Chancellor sees the top end of the housing market as a potentially lucrative source of tax. Homes already suffer special rates of stamp duty land tax. Stamp duty on share transactions is only 0.5 per cent, but SDLT is 1 per cent for houses worth between £60,001 and £250,000, 3 per cent for those worth between £250,001 and £500,000, and 4 per cent over £500,000.

Mr Marum says: "It is possible that the Chancellor will introduce an intermediate rate of 2 per cent on houses worth between £250,000 and £350,000. There is also an unwelcome suggestion that he will increase the top rate from 4 per cent to 6 or 7 per cent for houses worth more than, say, £1m."

The other scare, Mr Marum says, is that Mr Brown will start charging at least a partial capital gains tax on profits from selling your main home. The Treasury has denied this, making it unlikely to be unleashed next week, but it may stay in the pending tray until the spring.

The amount of tax-free capital gains allowed will probably rise from £7,900 to £8,200, in line with inflation, and Mr Brown is expected to confirm that dividends from shares held in Isas will be fully taxed from April. But he may abolish mini-Isas, letting savers hold £7,000 in a cash deposit. The Chancellor's other fairly new toy is national insurance contributions, in which from last April he imposed a 1 per cent surcharge for those earning more than £30,940 a year, in addition to the 11 per cent paid by everyone earning between £4,615 and £30,940. Adding another 1 per cent surcharge would raise £720m, and taking the 11 per cent rate to 12 per cent would raise a whopping £3.3bn.

But the original idea behind the Pre-Budget Report was for it be a "green" Budget, along the lines of Government Green papers containing consultations. This is where the pigeons really roost.

Among consultations winging their way back to base is residence and domicile, the question of how if at all to tax non-domiciled people, foreigners who are resident in the UK. A large number of wealthy individuals live in Britain on this basis without paying much tax, but the fear is that if they are charged much more heavily they could depart, taking their businesses with them.

Another big subject is pension reform. The Government has already proposed a limit of £1.4m on individuals' tax-free pension pot, which would be enough to yield a pension of nearly £100,000 a year. There have been calls to raise the pot limit to £1.8m.

The Treasury has rejected this, but a popular prediction is that it will compromise at £1.6m. The change will take effect from April, 2005. Other plans for which Mr Brown may sketch in more detail include child trust funds and stamp duty land tax.

As for fresh pigeons to be released, Mr Whiting tips studies of more widespread congestion-charging, environmental taxes and reform of council tax.