Tough task ahead to balance the books

We already know the Budget's going to be tough but what exactly will Osborne do to sort out the nation's finances?

Grant Thornton's head of tax, Francesca Lagerberg, says this is a make or break Budget for the coalition government which will test Osborne, leaving his critics to decide whether he has what it takes to be the Chancellor who can take the UK forward and provide much needed economic stability.

"The coalition government has been making substantial noises on the fairness agenda and so it is likely that this Budget will focus on families and low income earners," Lagerberg says. "So far the government has not shown much sympathy for middle income or high earners and this Budget does not look to offer them any small respite."

Last week Osborne seized on the findings of the Government's new fiscal watchdog to warn that things were "indeed worse than we thought". The Office for Budget Responsibility predicted that growth would be slower than former chancellor Alistair Darling predicted and that the black hole in public finances was bigger than expected.

Although Labour has accused the new government of scaremongering, it's pretty definite that tax rises and spending cuts will be announced on Tuesday. Income tax, capital gains tax (CGT) and pensions are all probable targets while benefits could be cut and the public sector could see pay cuts.

The coalition government has made it clear since taking office that there will be an increase in the rate of capital gains tax (CGT) to bring it more in line with income tax rates, although it has promised that reliefs for business assets will be retained.

But Patrick Connolly, head of communications at AWD Chase de Vere, says there is a real risk that CGT will become complicated if a range of anomalies and exemptions and some form of tapering or indexation are introduced.

"If the current CGT rate of 18 per cent is increased significantly without inflation-proofing or the CGT allowance cut drastically then the wrong people will be penalised," he says. "We must protect long-term savers who have prudently saved for their retirement."

Ed Bowsher, head of consumer finance at lovemoney.com, says the most likely tax increase is a hike in VAT. "I reckon George Osborne will probably increase the tax from 17.5 per cent to 20 per cent, raising an extra 13 billion per year as a result. Conservative chancellors often prefer to increase VAT rather than income tax as they believe that income tax discourages hard work," Bowsher says.

Just two weeks ago David Cameron warned that, without tackling the deficit, increasingly taxes would be used to pay interest on the national debt, rather than being spent on public services.

This year the budget deficit – according to Labour forecasts – is set to be more than 11 per cent of GDP. Britain's national debt stands at 770 billion and is forecast to be so bad that within five years the UK will be paying 70bn in debt interest alone and 10p in every pound paid in tax will soon go on interest payments.

"Osborne probably won't announce too many specific cuts as he'll want to wait for the results of the Comprehensive Spending Review in the autumn," says Bowsher. "However, I reckon he could well be tempted to announce some changes to child benefit right now. If the benefit was only paid to poorer mothers, the annual saving could be somewhere around 7 billion."

The infamous "jobs tax" – the previous government's proposed 1 per cent increase in employers' National Insurance contributions (NICs) from April 2011 – looks set to go ahead but the impact on employers will be mitigated by raising the threshold at which they start to pay National Insurance on each employee's salary. The proposed 21 per week increase in the threshold means that employers will save up to 150 per employee compared to the full 1 per cent increase.

Lisa Macpherson, national director of tax at PKF Accountants, says: "The current proposals to 'stop the jobs tax' are not as generous as employers may believe. The above changes do not mean employers' total NIC bills will go down in 2011/12: they just won't go up as much as they could have."

The coalition government is not likely to make any further announcement on headline income tax rates at this Budget but they have confirmed that they will raise the personal tax-free allowance (currently 6,475) to 10,000 over the lifetime of this parliament. This is of course good news for low income earners as many of them will be removed from paying tax altogether. Higher earners will feel little benefit as those with incomes over 100,000 no longer receive full personal allowances due to a change introduced in April this year.

"What we will see is further clarity on when the increased personal allowance will be introduced but it is likely that the allowance will lift between 700 to 1,000 in the first instance," says Lagerberg, "As this measure aims to help modest income earners we will see readjustments of the threshold at the upper end of the basic rate band."

The system of tax relief for pension contributions has been in upheaval since 2009 with a range of complex measures designed to reduce the rate and amount of relief given to individuals on high incomes. It's possible that the government will repeal the complex rules that are due to take effect from 2011/12 onwards.

"The pensions industry and many others are suggesting cutting the annual limit for qualifying contributions, from the current 255,000 level to perhaps 50,000," says Macpherson, "At this lower level, giving tax relief at the individual's highest rate, even if that is 50 per cent, would cost the government less than giving only basic rate relief on a contribution of 255,000."