The Chancellor sharpens his axe

On Tuesday, the Budget will be handed down

As with so many other annual rituals, the Budget is almost upon us. Ahead of it will come the pundits' predictions, followed shortly afterwards by the briefest of shrugs when their forecasts turn out to be totally wrong.

It is still useful to examine some of the options available to the Chancellor, Kenneth Clarke, if only so that should he rule against some of the more painful measures, it will almost seem as if he has done us a big favour.

Most experts believe this is likely to be an intensely political Budget, with the City's expectations of financial probity tempered by strong electoral imperatives.

Not that it has halted furious lobbying by interest groups. The Chartered Institute of Taxation, experts in tax law, have long argued for a simplified system.

David Frost, president of the CIT, says: "Urgent reforms are required, including a simplification of tax bands, a review of legislation covering employee benefits in kind and a commitment to integrate National Insurance contributions and income tax."

While root-and-branch reform is unlikely, Mr Clarke is expected to cut the basic rate of income tax, possibly by a penny or two, bringing it further down towards the 20 per cent target set by the Conservatives several years ago.

However, there is little hope that he will take millions of people out of the tax net altogether, by raising the personal allowance threshold significantly above pounds 3,765 or increasing the 20 per cent tax ceiling beyond pounds 3,900 on top of that. After all, there are precious few votes to be gained from such a strategy.

More likely are changes designed to ease the Capital Gains Tax burden faced by some investors on profits from the sale of shares and second homes.

CGT is fiendishly complicated to calculate and administer. The first pounds 6,300 of realised profits are free of CGT and, in any case, it is possible to minimise the tax further.

The Government has said that it would like to simplify and, if possible, abolish CGT completely. Politically, it would also send the right message to potential Tory deserters.

Options here include reducing the CGT rate or giving more relief to assets held for longer periods, theoretically rewarding "responsible" long-term investors.

Another area the Government may tackle is Inheritance Tax (IHT). Last year, Mr Major indicated he wanted to scrap IHT.

Mr Clarke raised the limit below which IHT need not be paid on a dead person's estate (including property) from pounds 140,000 to pounds 200,000.

Raising IHT levels, while seemingly generous, need not affect huge numbers, as most of us inherit well below the current pounds 200,000 tax-free limit.

One area where the Government may continue its inexorable march is the long-running reduction of mortgage tax relief (Miras). This has already suffered under successive Chancellors, having been cut from the marginal rate of tax to just 15 per cent by 1994. The pounds 30,000 mortgage limit for Miras has been frozen for years.

Last year, Mr Clarke's hand was temporarily stayed by a housing market in crisis. This year, prices have picked up and he may not be feeling so generous.

Paradoxically, the effect of a reduction in Miras may have a very minor effect on mortgage lenders' tendency to raise home loan interest rates. After the recent rise in base rates, most lenders said they would reserve judgement on whether to follow suit on mortgages until they digested the City's verdict on the Budget.

While unlikely, there may be a calculation in some quarters that a still- fragile housing market could ill-afford a combined attack from the Chancellor on Miras, plus an immediate raise in rates.

For potential home buyers who feel that the Chancellor is set to give away all bar the kitchen sink, thereby prompting the City to demand higher interest rates, fixing now is key.

While the Chancellor is unlikely to widen breaks for tax-free investments such as personal equity plans, he may act to rescue two forgotten higher- risk investments - Venture Capital Trusts and Enterprise Investment Schemes - that have not proved universally popular. Some experts hope the Government may increase VCT and EIS tax breaks from 20 to 40 per cent, in line with the marginal rates paid by many of their most likely investors.

For the rest of us, the hope is that Mr Clarke does not home in on easy taxes that have a high, but hidden effect on our living standards.

One such levy is Insurance Premium Tax (IPT), charged at a rate of about 3 per cent on anything from AA membership to travel insurance.

Despite claims in 1993, when IPT was introduced, that it would cost an average family just pounds 18 a year, the real figures are at least twice and perhaps three times that amount. The industry fears a doubling of IPT, leading to significantly higher insurance bills.

Sandy Dunn, managing director for Touchline Insurance, said: "A notable rise in motor insurance premiums across the industry is inevitable in the coming months. The fact that premiums have been kept artificially low by competitive pressures has already forced some players to leave the market.

"A rise in IPT would make the burden of rising premiums even greater for the consumer. Doubling levels would add another pounds 10 to the average motor policy."

Mr Dunn warned that one side-effect of such a rise would be to accentuate a trend among young or less well-off motorists towards cheaper third party-only insurance.

Whichever way the Chancellor moves next Tuesday, be prepared for some sleight of hand. Headline-grabbing tax cuts are one thing but it needs to be paid for somehow. One way or another, it will come out of our own pockets.

What they fear and what they expect from Mr Clarke

The hope

l Reduction in basic-rate tax by at least 1 per cent

l Rise in personal tax allowance above inflation

l Abolish 1 per cent stamp duty on house purchases above pounds 60,000

l Scrap or increase pounds 200,000 IHT ceiling

l Abolish or simplify CGT

l Increase investments in PEPs from pounds 6,000 to pounds 7,500 and single-company PEPs to pounds 5,000

The fear

l Increase in insurance premium tax

l Slash tax-free redundancy entitlements

l Increase in employers' National Insurance contributions

l Reduce or end mortgage tax relief

l Remove tax breaks from pension contributions

l Limit tax relief on popular PEPs or Tessas