Investment Comment
24th November 2023
A Budget in drag
With mixed headlines around the Budget, it is worth delving deeper into the Budget as ‘all is not as it seems’. With some press headlines celebrating a tax cutting Budget, and the more informed highlighting that taxes are increasing to the highest share of the economy since 1948, a closer examination and explanation is helpful.
Fiscal Drag
I’m going to start with some economic jargon for context . . . Fiscal drag happens when more people end up paying higher tax, even when headline tax rates remain the same (or are cut).
High inflation and higher wages has meant that tax revenues have increased by more than expected in recent years. Wages increased by 8.2% in the second quarter of 2023, which was 2 percentage points higher than expected even in March 2023.
Research from the Institute for Fiscal Studies (IFS) calculated that freezing the income tax allowances is expected to result in £23.4 billion extra tax revenue in 2025-26. Back in 2020-21 this freeze was expected to ‘only’ result in £8.2 billion. Maybe the tax man has been the biggest winner from inflation? These higher tax revenues resulted in a lower (better) than expected fiscal deficit, and reduced government borrowing.
The freezing of the personal allowance has resulted in a sharp rise of adults paying income tax
Source: Artorius, Institute for Fiscal Studies
A higher proportion of taxpayers are paying higher rate income tax
Source: Artorius, Institute for Fiscal Studies
More people are paying tax and more of it. The share of adults paying higher (or additional) rates of income tax is shown in the chart above. The Resolution Foundation projects that if the higher-rate income tax threshold continues to be frozen, almost one-in-six adults would pay higher-rate tax in 2027–28, a record high. In other words, in that year, there would be almost 80% more individuals paying higher-rate income tax than there would have been had the threshold been inflation indexed.
And it's not just the ‘high’ paid that are getting caught. By freezing the personal allowance, individuals with relatively modest incomes (above £12,570) will have to pay income tax. Again, if the allowance had been uplifted in line with inflation then fewer households would be facing basic rate income tax.
Impact on employees of this Parliament’s Income Tax (IT) and National Insurance (NI) policy changes in 2027-28: UK exc. Scotland
Source: Artorius, Resolution Foundation
Taxes as a share of national income continues to rise
Source: Artorius, Institute for Fiscal Studies
NOTES: Threshold changes include the impact of the NI changes as well as Income Tax and NI threshold freezes. Excludes any impacts from higher employer NI. Does not include the impact of Universal Credit means-testing.
And the winner is… yesterday’s loser?
Overall, the measures in the Autumn Statement will boost household incomes across the distribution, with the typical household £500 better off in 2027-28. The richest households will gain the most, with the top fifth benefiting to the tune of £1,000 a year on average, five times the gains for the bottom fifth. But while the top gain most from the Autumn Statement, they have also borne the brunt of decisions by Parliament (post the 2019 General Election) as a whole, largely reflecting the big increase in personal taxes. Taking all tax and benefit measures announced since 2019 together, we find that the richest fifth of households lose an average of £1,100 a year, while the poorest 20 per cent gain £700.
Measures in the Autumn Statement boost incomes of middle- and high-income households more than those lower in the distribution
The tax and benefit changes announced in the Autumn Statement have only a small effect on household incomes compared to previous policies in this parliament
Source: Artorius, A pre-election Statement: Putting the Autumn Statement 2023 in context, Resolution Foundation, November 2023
Data is shown in 2024-25 prices. National Insurances changes include cutting the main rate of employee NI by 2p, cutting Class 4 NICs by 1p, and abolishing Class 2 NICs. Local Housing Allowance (LHA) was increased to the 30th percentile of local rents. Work Capability Assessment (WCA) changes refer to changes made to the WCA for people with certain disabilities to access support. Capital Gains Tax (CGT) and pension tax changes includes changes to Capital Gains Tax entrepreneurs’ relief, reduction in the CGT exempt amount, and increases to the annual allowance and abolition of lifetime allowance in pension taxes. Existing benefit changes includes the uprating of the Pension Credit with the Consumer Price Index in 2023-24, the cut in the taper rate, increase in work allowances, increase in LHA rates to the 30th percentile of local rents in 2020-21, the 7 per cent uprating of social rents in 2023-24, benefit cap uprating in 2023-24, and higher caps for Universal Credit (UC) childcare. Existing tax changes includes Income Tax threshold freezes, the National Insurance threshold rise and subsequent freeze, Income Tax additional threshold reduction, increase in dividend tax rates and reduction in dividend allowances.
Stock concentration
The performance of the global equity markets has been dominated by the Magnificent Seven (Apple, Microsoft, Alphabet (Google), Amazon, Nvidia, Tesla, Meta (Facebook). The Magnificent Seven have gained 102% while the other 493 stocks in the S&P 500 US equity index have gained less than 9%. Given the benchmark's market cap distribution, which allows larger stocks to contribute more to the index's movements, the S&P 500 has returned about 18% this year. This is after the 45% loss for the Magnificent Seven compared to the index loss of 19% in 2022, highlighting that the seemingly ‘one-way’ bet of large cap technology has come with bumps in the road.
After the rally in 2023, the largest seven companies in the US account for 29% of the market capitalisation of the S&P 500. This is the highest seen over the past 40 years and is seen as a risk for the overall S&P 500 market. With the fate of the index in the hands of so few companies, many are worried that a fall in one or more of the ‘7’ will have an overly problematic impact for the investor. We think that this may be the case, but also highlight that the concentration risk (of around 30% of the index in the top stocks) is similar to that in Europe (excluding the UK), but is surpassed by the UK equity market concentration risk, see chart below. The largest 10 stocks in the UK (as captured by the MSCI UK index) account for over 50% of the equity index. Unlike the US Magnificent Seven, the UK equivalent appears to have the quality of elephants… they don’t fly.
US S&P 500 equity returns in 2023: Magnificent Seven dominate the return profile
Source: Artorius, Bloomberg
UK equity market is highly concentrated, with over 50% of the index in 10 stocks
Source: Artorius, Bloomberg
All expressions of opinion reflect the judgment of Artorius at 24th November 2023 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions. Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.
FP20231124001