The '2 and 20' Budget: More Tax Rises on Financial Assets to Come

I’m dubbing last week’s UK Budget the The “2 and 20” budget for two reasons:

Firstly, the increase of 2 per cent in the taxation of income from financial assets.

Secondly, the reduction from 30% to 20% in upfront tax relief on contributions to venture capital trusts.

In themselves, these measures raise limited revenue (the savings interest tax increase of 2% from April 2027 is estimated to raise £525m in 2028/9) and the dividend and savings tax increases might be seen as a left-over of the abandoned plan to increase income tax rates by 2%, but correspondingly reduce employee National Insurance contributions by 2% (which would have raised about £6bn per annum).

However, the justification for the measures in the Budget documents indicates this is just the start, as this extract from the Budget 2025 explanatory document demonstrates:

This framing signals a decisive shift in the balance of taxation. The ultimate goal is to at least match the tax rates on financial assets with income tax and national insurance combined (i.e. 28% for a basic rate tax paying employee).

The think-tank the Institute for Fiscal Studies Green Budget 2025 refers to the “tax penalty on employment” as the taxation of interest and dividends being at a lower marginal rate than income tax and national insurance contributions combined (28% for basic rate income tax payers in employment). Such views are clearly the foundation of government policies towards the taxation of financial assets.

The 2% increases in the 2025 Budget may well be followed up by a 2% increase in each of the next 4 Budgets to bring the tax rate on savings interest and property income to 28%. The basic dividend tax rate increase from 8.75% to 10.75% in the 2025 Budget is also likely to be the first of several such increases.

And who’s to say these increases stop there? Once the principle has been established of a higher rate of taxation on financial assets, memories will be stirred of ‘the investment income surcharge’ which applied an additional 15% surcharge on what was termed ‘unearned income’ until its abolition in 1984.

What such measures overlook is that for savers and investors like myself, the capital generating investment income was very hard-earned, by myself, and my ancestors, and derives from that saved after income had already been taxed.

It is somewhat galling to be taxed again, potentially in the future at higher rates than those in employment, with the proceeds used to support many who have not prudently provided for their own and their families’ futures.

It’s almost as if the government wishes to deter private saving and self-reliance, and instead extend the numbers dependent on the state.

The 2025 UK Budget: For Whom the Bell Tolls

 

Torsten Bell MP

“send not to know

For whom the bell tolls,

It tolls for thee.”

(John Donne)

To continue, and slightly modify, the John Donne reference, no investment portfolio is an island, entire of itself. Context matters.

In the UK this week of November 2025, the annual taxation and public expenditure statement, the Budget, to be given in the House of Commons on Wednesday 26^th November, has been widely trailed to include both an increase in the overall level of taxation, and a significant shift in its burden towards levies on capital and financial assets, rather than labour – hardly surprising for a Labour government.

In a previous blog post I queried whether the Chancellor of the Exchequer, Rachel Reeves, was the most important financial actor shaping the investment landscape. Recent pronouncements leave little doubt that the Budget is now being decisively shaped by pensions minister Torsten Bell MP, recently detailed to ‘assist’ with Budget preparations, and others with a background in the centre-left think-tank the Resolution Foundation.

 

Many of the Resolution Foundation’s policy ideas - as expressed in a September 2025 paper Call of Duties - are now accepted as orthodoxy, the only question being the scale and timing of their implementation. 

Not only do such measures align a beleaguered front bench with increasingly restive backbenchers and capitalism-sceptic Labour party members, they chime in with the UK Treasury's single-minded focus on plugging the fiscal deficit.

Thus, from the next tax year starting April 2026 it is highly likely that:

- Dividend tax and capital gains tax rates will be increased.

- ISA investment rules will be modified, to at the very least channel investments towards UK-listed entities.

- Estates on death, gifts, and pension-related savings will be taxed in higher and most likely more complicated ways.

The investment implications of the Budget of course go well beyond micro-taxation regulations. The extent to which the bond and foreign exchange markets perceive sufficient fiscal consolidation will determine both the near-term and longer-term rates of interest, with potentially cross-cutting impacts on sectors with differential interest rate sensitivity.

It's possible to imagine a scenario where interest rates come down more rapidly than currently envisaged, broadly favouring many equities, so stock market returns could be enhanced, but the post-tax and post-inflation returns investors, especially UK retail investors, reap thereafter may be limited.

More tellingly, the long-term direction of travel of future Budgets will be set: higher taxes on capital will be the first source looked to for higher tax receipts.

Rachel Reeves’s successors as UK Chancellor will be back for more many years into the future, particularly given the growing popularity of the Green Party in the UK which increases the possibility of a long-term centre-left Red-Green coalition being the dominant governing force for decades hence.

In Three Words: What Investors Should Seek

 Scarcity, distinctiveness, undervaluation.

Small Cap Funds: How Small is Small?

In a previous blog post I outlined a search for a global small cap fund.

My chosen vehicle, Marlborough Global Small Cap, is not available on my SIPP platform, AJ Bell, so in beginning to consider where to invest my 2025/26 tax year's SIPP allocation, I've once again been scouring for small cap investment ideas, mainly, but not exclusively, small cap funds.

As the above graphic from the 2024 Deutsche Numis Indices Annual Review illustrates, seasoned investors in UK small caps keep the faith for two main reasons:

1. Over the long-term, small caps have outperformed.

2. Within small caps, the smallest companies outperformed the most.

To be more specific, using the Deutsche Numis data, from 1955-2023 in the UK: the annualised returns from an investment in the Deutsche Numis Small Cap Index (DNSCI), the Mid Cap, and Large Cap indices (all ex-Investment companies) were 14.1%, 12.8% and 11.0%, respectively.

For the very smallest companies, the return on the Deutsche Numis Small Cap 1000 Index of the DNSC 1000 (XIC) the return was even higher at 15.7% p.a.

In monetary terms, this means, including re-investment of dividends, £1 invested in 1955 in the smallest companies would have been worth £22,572 by the end of 2023. This compares to £9,171 for the DNSCI, £4,159 for the Mid Cap and £1,357 for the Large Cap.

However, seasoned investors in UK small caps have had to stretch that definition of 'the long-term' to retain that faith in small cap outperformance. 2024 marked the third year in a row when the Deutsche Numis Small Cap Index under-performed its long-term average, returning 9.5%.

That said, some individual funds have bucked that trend, despite the pall of gloom overhanging the UK economy and stock market.

Interestingly, taking the calendar year 2024, three of the best performing UK small cap investment vehicles specialise in the smallest companies:

Rockwood Strategic had an NAV return of 25.4%.

The Onward Opportunities Trust returned 23.4%.

River UK Micro Cap's NAV grew by 19.9%.

I already invest in first two, and may consider the River UK Micro Cap trust, not least as activist investor Saba Capital has been building a stake, up to 14.1% as of January 9th 2025, possibly a prelude to the next wave of requisitions and potential corporate action.

Comparing smallness across different geographies

To revert to the title of this post, how small is small in different contexts?

I've recently discovered it's possible to rank open-ended funds on Morningstar by average market cap of portfolio holdings.

For UK smaller companies, the open-ended counterpart to Onward Opportunities, SVS Dowgate Wealth UK Small Cap Growth, has the second smallest average market cap of £69m. For comparison, the River UK trust's average is £102m.

These numbers are far smaller average company sizes than other geographies.

Europe: The frustratingly platform unavailable Schroder Nordic Micro Cap fund has an average market cap of £223m.

Japan: Daiwa Japan Equity Small Cap Absolute Value £151.25m.

Asia Ex-Japan: Matthews Asia Discovery £1.865 bn.

USA: FTGF Royce US Small Cap Opportunity £1.062bn.

Interestingly, despite its micro cap label, the again frustratingly unavailable Heptagon Driehaus US Micro Cap fund has an average market cap of £2.01bn, almost double that of the Royce fund.

Lesson learnt: Don't assume a fund calling itself micro cap fund is investing in the very smallest companies.

Still no global micro cap fund

Once again, I'm left lamenting the absence of a genuinely global micro cap investment vehicle. Perhaps an investment firm could do for the micro cap space what Alliance Witan has done for the larger cap universe and bring together a series of micro cap investors specialising in different territories into a single 'best ideas' global micro cap investment vehicle?