Merlin Weekly Macro: On tax, the devil is in the detail

Going with form the European Central Bank cut its deposit rate from 4% to 3.75%. We analysed the broader picture and the outlook in last week’s edition. There is nothing to add. Today, we focus on politics.

To whatever effect, half the world is voting this year

Elections are an unavoidable preoccupation. In one form or another, around 2.5bn people around the globe have already voted or will be exercising their right to vote in 2024. However questionable their democratic credentials, elections have already taken place in Russia and Iran. More recently, South Africa and India went to the polls and in both cases the incumbents were frustrated: as widely expected in South Africa the African National Congress (ANC) lost its outright majority for the first time since the end of Apartheid; in India, Narendra Modi’s Bharatiya Janata Party (BJP) remains the biggest party but totally against the expectation of another large victory, not only was there no landslide, the BJP lost its majority prompting a bout of significant volatility on the Indian stock exchange.

Farage: the end of the Phoney War?

In the UK, of course, two weeks into the campaign (is it really two weeks? It seems like an eon already and we are still only a third of the way there), it is a subject that is impossible to avoid such is the media saturation. Nigel Farage spinning 180 degrees and not only deciding to stand (“you are allowed to change your mind you know!”) but also engineering a one man bloodless coup to usurp Richard Tice as the Reform Party leader, certainly gingered up the proceedings. At the time of writing there has only been one major poll since Farage’s candidature was announced to give an inkling whether his unexpected intervention is a mere ripple in the Westminster pond or something more seismic, particularly in the former Brexit/Red Wall seats; for what it is worth the YouGov poll concerned indicates Reform surging to 17% from 14%, only two points behind the Tories.

The ITV head-to-head between Sunak and Starmer (known irreverently to the author as ‘Sunk and Starter’) created little heat and even less light; on the other hand, the debate scheduled for 7ᵗʰ June pitting an array of political attack dogs (Farage, Labour’s Angela “Angry Ange” Rayner, Stephen Flynn for the SNP, even Penny “The Sword Bearer” Mordaunt), should produce sparks if not enlightenment.

However, until formal manifestos are published, so much electioneering is a melange of mudslinging and obfuscation mixed with occasionally road-testing out-of-the-blue new policies (such as Sunak’s community-service-or-boot-camp initiative). We await with interest the substantive policy details which will allow a proper analysis of the genuine points of differentiation between the principal protagonists on the key subjects of the economy, fiscal policy, public services and public sector reform, health, education, defence, energy, post-Brexit relations with the EU, immigration and social policy.

Tax: the devil is in the detail

When Labour says breezily and evasively that it will “not increase taxes for working people”, what in this context defines a ‘working’ person? Without definition it is a phrase wreathed in disingenuity. Leaving aside the veracity or otherwise of Sunak’s sweeping allegation that Labour will land every ‘working household’ with an extra £2000 in tax (seemingly over four years and not annually, on subsequent clarification), Starmer and Rachel Reeves owe the electorate an open and honest exposition of their future tax policy.

This is not merely about the rate at which Income Tax, National Insurance (NI), Capital Gains Tax (CGT) and Inheritance Tax (IHT) will be charged. From painful experience of persistent fiscal drag, we all know that it is the levels at which each is applicable and to what they are applied which matters every bit as much as the headline rate. While Labour has committed not to increase the rates of Income Tax and NI, giving the impression that the amount of tax appropriated will not change, it is obvious that freezing allowances and bands draws more people into higher tax brackets and increases the nominal tax take; their position needs clarification.

Deputy Leader Angela Rayner has made no secret of her desire to see the restoration of the rate of CGT being ‘harmonised’ with the taxpayer’s marginal rate of Income Tax. It has also been suggested by economists at Warwick University and socialised for discussion among Labour’s policy makers that National Insurance (10%) should be applicable to all sources of unearned personal income (e.g. rent from investment properties, share dividends, bond coupons etc). Would Labour repeal the CGT exemption on UK Gilts and primary residences? Reeves wishes to reform Council Tax with a clearer definition and differentiation between bands; in all but name, Council Tax is a property tax. Also mooted as being in the firing line but yet to be clarified is the IHT status of agricultural land, currently exempt.

Equally the Tories need to clarify their own position on IHT; a divisive topic among Conservatives ahead of the March Budget but subsequently left alone, Jeremy Hunt recently described IHT as “unfair”; would he scrap it? Or would he keep it but significantly increase the tax-free allowance? Given the budget constraints for public spending, if IHT were to be binned, where would the government find the approximately £7bn a year in foregone tax receipts?

So many questions, so far so few answers. Beyond the trite and the soundbite, tax remains largely a policy vacuum.

The political landscape beyond July 4ᵗʰ

Much can change but the polls currently point to a Labour landslide; it is far less a question of whether the Tories will lose as it is guessing by how much. In our ‘first past the post’ system, complicated in 2024 by national factors in the devolved nations and particularly Scotland, forecasting the Westminster maths is a futile pastime. Two pre-Farage polls this week illustrate the point, both based on very similar headline voting intention data: for the four main parties YouGov/Sky predicted Labour with 422 seats, the Tories 140, LibDems 44, the SNP on 17 leaving a Labour majority of 194; Electoral Calculus predicted Labour with 485 seats, Conservatives being virtually annihilated with 66, the LibDems with 59 and the SNP 34 giving a Labour majority of 320. In context, in 2019, the Tories won 376 seats, Labour 197, the LibDems 8 and the SNP 48, a Tory majority of 80. To demonstrate the risk of error in forecasting seats derived from nationwide polling data on limited survey population samples, in 2019 the Tories won those 376 seats with 44.7% share of the national vote; in 2024 the Electoral Calculus poll predicts Labour winning 485 seats with exactly the same share of 44.7%.

Labour would be ecstatic with either outcome; both would allow them to get things done (deliver Starmer’s yet to be defined “change”) unimpeded. However, from the point of view of good governance, a weak and fractured opposition is seldom effective at holding the government to account and keeping excessive behaviour in check. The situation will be worse if the Tories lose so badly that as a party they implode and become dysfunctional. With Labour, the LibDems, Greens, SNP, Plaid Cymru and the non-Unionist parties in Ulster all being politically left of centre and in some cases well to the left, the fewer Tory seats the greater the likelihood of a left-dominated parliament with diminished sense of perspective or balance.

No party has a divine right to rule or endure, even the British Conservatives widely held, up to now, as the most ruthless, successful political party in democratic history. In the event of near melt-down, how quickly would the Tories be able to consolidate, regroup around a new leader and reinvent themselves? How many leaders will need to be dispensed with before they find the right one? Or will they literally disintegrate and in time from the rubble a new “one nation” party emerges at the centre while an alternative builds itself around Reform to the right? Love him or loathe him, Nigel Farage is probably the most influential British politician of this generation; we have absolutely no doubt that whether he wins Clacton and a seat in parliament for Reform or not, his influence will remain pivotal in the development of centre-right politics for the foreseeable future.

The EU’s polling doors are open: so what?

At the time of writing, voters in the EU are already going to the polls in this weekend’s EU parliamentary elections. While the UK is trending left, the pre-election evidence is that in Europe the momentum is towards the right. Polarisation left and right at the national level among member states has been a feature of EU politics for several years. The factors are no different from other democracies: the increasing economic divide between the haves and the have-nots; immigration; climate change politics; and the divisions created by that pejorative phrase “the politics of woke”. The EU parliament is the least influential and effective of the four pillars of EU governance (the Council of Ministers, the Commission, the European Court and the Parliament); the result will be of little practical relevance to how policy is formulated and implemented in the EU. However, the election is an important pan-EU barometer of the political lie-of-the land at the grass roots level. Herein is a more fundamental problem.

The von der Leyen enigma

EU Commission President Ursula von der Leyen is concerned about the democratic threats posed by populism. She is nervous of the threat from the far right which she sees as being particularly susceptible to manipulation by malign players such as China and Russia (the same susceptibility could equally be laid against the far left too through protest groups such as Just Stop Oil and Extinction Rebellion, but her specific concern is the right). In danger of confusing disagreeing with being actively subversive, she wants to “inoculate” the electorate against disinformation by a programme of political “education”. She has no awareness that taking an Orwellian, centrist and patronising approach which treats the electorate as poodles and idiots is precisely what feeds populism. She wants to close debate down rather than allowing it to take place and be challenged in the open. Hers is an unwise course.

As part of her pitch to be re-elected, what she should constructively be advocating is pan-EU governance reform, creating an environment which is wholly inclusive of the electorate, rather than dismissive virtually to the point of it being disenfranchised (‘virtually disenfranchised’ in the sense that while people have the right to vote, their vote is essentially worthless). The Commission of which von der Leyen is President is much of the problem; in a case of perception becoming reality, the Commission seems to labour under the misconception that it is the de-facto government, when in fact it is the EU’s civil service.

Who gets the EU top jobs is due to be decided in July. Von der Leyen herself is on shaky ground, reportedly losing the confidence of Germany’s Olaf Scholz and President Macron of France. If she is ousted, no doubt her name will again be touted as a candidate to be Secretary General of NATO, as favoured by Joe Biden. Her lamentable record as German defence minister, her support as a minister for Merkel’s demonstrably disastrous appeasement of Russia, her ambivalence about how to deal with China, her connivance with Macron last year to suspend munitions deliveries to Ukraine in the middle of a war while the EU put greater importance on integrating its procurement processes, all point to her being the wrong choice to lead NATO.

The US: fireworks on November 5ᵗʰ

The author recalls a conversation with a Democrat friend a year ago about Trump: “we’ll nail him, Alastair. If it’s not Stormy Daniels, it’ll be something else. But we’ll get him”. So it came to pass. President Biden’s immediate public response to Trump’s conviction in which he explicitly conflated the court case with the election was a tacit admission that the prosecution was politically motivated. As a former New York District Attorney aired her opinion to the BBC, it was a very unwise move by the Administration directly to make such a connection. This is merely the first of Trump’s four trials. Whether “nailing” Trump in this or any of the others produces the outcome the Democrats seek, to keep him out of the White House, is quite another matter.

We have no idea how this ends; it will not be decided by the dyed-in-the-wool Democrats or Trump hard-core supporters but by the 10%-20% of the electorate who are floating voters yet to make up their minds. But whoever wins the election, America’s international standing is diminished. Domestically it will be deeply divisive, if more political division in America is possible.

If Trump is confirmed as the Republican nominee and goes on to win the White House, the near half of Americans who vote Democrat will declare the slightly more than half who voted Republican as unprincipled and irresponsible, giving legitimacy to a convicted crook; what does that say about their morals and are they not ashamed to bring the United States into disrepute and make it not only a laughing stock but one which makes third rate banana republics look respectable? Equally, for the Democrats, it will be lodged on their record book that Biden will go down in history as not only the worst President on record, but also being so utterly useless that he managed to lose the election to a proven felon; they chose him and endorsed him.

If Biden wins the election, Republicans will declare that President Biden abused his position as head of state, manipulated the legal process to his own advantage (to which his ill-considered press release in the wake of Trump’s conviction only adds evidence to confirm their suspicions) on which grounds he is not fit for office and the election is a sham.

Bad for America and Americans, it is directly relevant to the rest of the Western alliance in a period of such instability when firm, principled and unimpeachable leadership is required. Moscow, Beijing, Tehran and Pyongyang must be watching on amazed and delighted that the democratic global superpower, the leader of the Free World, has decayed so far.

Evident from all this discussion about elections, results are very difficult to predict with accuracy. As ever, our stance in such situations is to consider the potential outcomes and react accordingly after the event; we do not try to anticipate and bet on binary situations over which we have no control.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each.  With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.