Comment on this article to comment@patrickminfod.com
Comments so far:
Dominic Whittome
Terry Griffin
Colin Sutherland
Richard Hawkes
Chris Whitbread
Bryan Meeds
James Manning
Dear Professor
Looking to the near future, it is clear Mr Brown soon needs to raise more in tax. Falling employment/incomes will see to this.
Question is, which ones should he increase this time round - now that the obvious stealth options have been tried and, as your very interesting article in today's Telegraph explains, also taken their toll on our economy.
What about our many foreign guests who enjoy duty free shopping from hi-fi equipment to M&S jumpers ?
Why do we still have this rebate system which must transfer a hefty additional burden to others?
Foreign guests rightly expect police, emergency medical, sensible transport and other services to be provided and surely they should contribute?
A precedent for taxing foreign guests in respect of VAT was established long ago with the practice of airport landing charge so why shy off from the retail sector.
Besides if any sector of the economy could do with a leg-up its manufacturing, who presumably will be meeting part of Mr Brown's shortfall under the Climate levy
Can the UK withdraw from this (international?) agreement and start VA-taxing everyone the same ? Or is that illegal for us to try ?
Dominic Whittome
Dear Mr. Whittome, Thanks- an interesting idea. However, VAT is by its nature a tax on spending by home residents which is rebated on exports/spending by foreigners. The reason is that to widen it would make it an export tax and so an interference with free trade within the EU. Thus we are simply not allowed to do this. I also don't think trade taxes are in our interest as basically a free trade country; indeed our interest lies in getting the EU to become far more genuinely free trading than alas it is. So if we did this, they would have even more excuse not to!
yours sincerely,
Patrick Minford
Dear Patrick,
with regard to the future abolition of tax on US dividends I have seen no comment with regard to the beneficial effect for the Chancellor. As you know there is a double taxation agreement between UK and USA. Accordingly, with nil tax being deducted at source the Inland Revenue will increase its Tax take. It will not be the case that there will be any overall benefit to any UK investor. Do you agree or have I got it completely wrong.
Best wishes
Terry Griffin
Interesting point. For UK residents paying income tax what you say must be true- I don't know how much is involved though as most US equities will be held by pension/insurance funds which are non-taxable. For non-UK-domiciled holders no UK income tax liability arises.
Dear Mr. Minford,
Enjoyed your column in today's DT.
Of course, the more complicated the tax, the more expensive to collect it.
Didn't an American think tank come up with 18%, with no exemptions whatever, as being the optimum rate that would achieve the highest returns to the Treasury of the country concerned? The reasoning was that the rate was low enough to knock out all the normal tax dodges, simple enough to cut back on tax inspectors(make a change to have unemployed tax inspectors instead of unemployed bankers!) and would boost the economy.
Regards,
Colin Sutherland
Dear Mr. Sutherland, thank you, too right! I think you are referring to the US 'flat tax' proposals, which indeed I have written about in the past. It has the advantages you mention as well as greatly enhanced economic efficiency because the distortions increase with the marginal tax rate.
Yours sincerely,
Patrick Minford
Dear Professor Minford
I was most interested in your article today, and would like to put some comments and questions to you for your consideration. By way of background, I am an actuary who was until recently a partner in a firm of consultant actuaries. I therefore have some knowledge of economics, but would in no way consider myself an economist.
As you say, back in 1997 the Chancellor removed ACT (Advance Corporation Tax), and I think it is fair to record that he did at the same time modestly reduce the rate of CT (Corporation Tax). Actuaries, for better or worse at that time, often valued pension fund assets by assuming that all or part of the portfolio was held in UK equities and then by discounting a stream of future gross dividends increasing at around 1% p.a. above the rate of inflation. That would typically have valued the fund then, from memory, at about 85-95% of its market value.
The first order effect of the loss of ACT, which I think was 20%, was thus to reduce the value of the fund to about 70-80% of its market value. However, some of the assets would have been in bonds and overseas equities, there was a prospective gain from a lower rate of CT, and there was an expectation that companies might well restructure their capital with more bonds and less equity so that funds could recoup some of the lost ACT. An estimate of the reduction would therefore have been less than 20%, perhaps 10-15%, dependant on one's view of the actual fund being investigated.
Whatever value actuaries actually put on the fund, however, there was indubitably a reduction of cash flow into the funds of around £5bn per year. Some of that loss fell on money purchase funds, so that employees, as future pensioners, suffered the loss personally (as an aside, how many realise that there is that loss?).
The rest of the loss fell on defined benefit pension funds, and thus principally on companies. This is where a second order loss begins to creep in, since companies would need to put more money aside to refinance the pension funds, and thus their profits (and ultimately dividends) would be lower, so the value put on their shares, whether market or "actuarial", would also fall. That will have had a knock-on effect on all pension funds, so there will be further additional funding needed from the employers, a further loss in profits, and so on.
The position has been made worse by a sharper-than-expected improvement in mortality, by the new Financial Reporting Standard expecting pension funds to be valued by reference to bond yields, and by the sharp change in real yields on bonds from over 3.5% in June 1997 to around 2% at the present time. This latter alone has had the effect of adding about 15% to the value of pension liabilities. This means that the effect of pension funds on company balance sheets and revenue accounts, already under pressure from world-wide competition and increased regulation, has been depressive, and to a large extent in the case of companies in declining industries which used to have large workforces.
Your article does not mention these secondary and tertiary effects, and I wondered to what extent your models take these sort of considerations into account. Do you think that the market values of shares fully reflect the damage that this Government seems to have done to British Industry since 1997? How much of the fall in the UK equity market can be put down to internal causes such as those discussed above, and how much to external factors outside the control of the British Government? Could any of this have been avoided by NOT becoming more closely entwined with the European Community? Do you think the general population has any inkling of all this?
Or is my analysis wrong, and am I barking up the wrong tree?
By the way, I appreciated the article you wrote for the 150th Jubilee of the Institute of Actuaries some five or six years ago now, and still have the booklet the Institute then produced.
Yours sincerely
Richard Hawkes
C R C Hawkes MA FIA
Dear Mr. Hawkes, Many thanks for your interesting letter and kind words.
The basic point I was trying to make was that the price of UK equities would fall. I am not really sure what you mean by secondary and tertiary effects- presumably that other funds suffer from the direct consequences of the extra tax. True indeed. The incidence of this measure was plainly quite complex-
The trouble about the measure was that it was designed to stimulate investment but because poorly designed did the opposite. It is yet another of New Labour's interventionist tax measures. As a stealth tax too it therefore has poor side-effects- if Labour needed revenue it would have been better to raise it via general taxation.
Yours sincerely,
Patrick Minford
January 14, 2003
Dear Professor Minford,
Back in 1997 we would have assumed that dividends would have continued at the same level as before the removal of ACT, and that the pension fund would then have had a reduction of, dependent on its asset allocation, 10-15% in the investment income it would receive in future. This might be termed the primary effect on pension funds.
What we may not have taken into account is that all companies and their funds would be going through the same process, that they would therefore all be told that they would need to increase contributions to the funds, and thus that their reported profits would be lower. This would presumably have a long-term adverse effect on dividends, so that one should have made the assumption that dividends would NOT have continued at the same level, so one should have further reduced the value of the fund's assets. This might be called the secondary effect.
This suggests that the opposite of a "virtuous circle" would then result, with tertiary and subsequent adverse effects.
The loss of ACT has subsequently been exacerbated by the fashion of taking bond yields much more into account, the under-supply of suitable bonds, the consequent reduction in bond yields, and the corresponding increase in the value put on the pension liabilities. This may be about to unwind as the Government's borrowing requirement over the next few years may result in yields rising again; this would result in the market values of bonds falling, so is this something you are expecting for the next few years?
Yours sincerely
Richard Hawkes
Dear Mr. Hawkes,
Yes, I see your point now on 'secondary'- that in so far as firms have given pension guarantees they must top up out of profits/dividends. I suppose one would want to distinguish between the 'primary profits flow' and the 'capital gain/loss element' in corporate performance. Every time a share price changes there must be some implicit capital effect of the balance sheet which should really be netted out.
Yours sincerely,
Patrick Minford
Dear Professor Minford,
I read your article in yesterdays's Telegraph and have the following comments.
(I'm a PhD student at Birkbeck College, London.)
First, the rise and fall in the London stock market (as in the New York and other stock markets) over the last ten years owed much more to the development and collapse of a bubble than to any tax changes made by British chancellors.
Second, most investment by companies is not financed by new share issues, but from retained profits. The cost of capital that companies look at is not determined by the price of their shares, but, as you point out, by what they could obtain by investing their profits elsewhere.
An alternative view is that the investment of firms is only affected to some extent by calculations about whether they could do better by, for example, buying bonds or shares of other firms around the world; and that only in some firms (those that don't have growth as a prime objective) are investment decisions made solely on the basis of expected profits, although these are important.
Instead, investment is largely determined by what Keynes called "animal spirits", a vision of the future and a desire to see your company grow. Perhaps the top managers of British firms just don't have enough vision or belief in the future.
You state that increased taxation of dividends will lead to an actual reduction in the capital stock of British business. That would be unprecedented in modern times, and I await evidence that firms are reducing their stocks of equipment, buildings, etc., which would back up your analysis.
Please continue your Telegraph articles - I always try to read them and find them very thought-provoking.
Yours sincerely
Chris Whitbread
Dear Mr. Whitbread,
Thank you for your kind and interesting letter. First, let me wish you the best of luck in your PHD.
Of course many of the things you say are completely correct. What I was dealing with was just one effect out of a multitude of factors affecting investment. I did not say that the capital stock would actually fall in real time! That would be absurd.
The evidence for one such effect would be difficult econometrically to find; possibly event analysis would be a way given that we have rather precise timings of these measures. The relative movement in the UK/US stock market is certainly suggestive.
My piece was designed to bring readers' attention to the implications of general equilibrium theory which seems to have been neglected by the Treasury and the tax accountants who were so keen to recover the ACT they were 'giving away'.
yours sincerely,
Patrick Minford
Dear Patrick Minford,
Your article in yesterday's Daily Telegraph Business made interesting but difficult reading.
There is no doubt that you are right that if the return on a particular investment goes down then an investor will not be prepared to pay as much for that investment if he can do better elsewhere. Thus Pension Funds, for example, will be looking to pay less for their shares in future because their income therefrom has been reduced. Since they are big investors this is likely to reduce the valueof shares with the sort of implications you mention. Unless Mr Brown and his colleagues have some hidden agenda it would seem they have simply not thought through the consequences of their actions
With regard to Advanced Corporation Tax (ACT) and pension funds your remarks do not appear to offer the required clarification of what Mr Brown has done.
It is important to note that provided the dividend is covered adequately by profits the ACT does not affect the total tax payable on profits. That is to say, the tax on profits is the same with or without ACT. The main purpose of introducing ACT was to bring forward the collection of tax on profits by the Inland Revenue. Abolishing ACT therefore does the reverse and improves the cash position of a business since it no longer pays its tax in advance. In this respect it is legitimate for Mr Brown / Labour to say that this is helpful to business.
The effect of the change in the tax regime on personal savings held in Pension Funds is however a separate issue to the change in ACT. Not only is the pension change a stealth tax it also results in the same income being taxed twice.
It is worth restaing that a Pension Fund is nothing more nor less than personal savings accumulated by its members. The general principle is that people are encouraged to make these savings initially on a special tax free basis with a view ultimately to paying less tax when these savings are taxed when withdrawn in the form of a pension. This general principle has been breached because via the Pension Fund tax change members are now obliged to pay tax on their savings when received as dividend from taxed profits. Personal savings in pension funds are no longer accumulating on a tax free basis.
In contrast to the new tax on pension savings, all the withdrawals from these savings in the form of a pension continue to be taxable as income. This means that as far as members' dividend income is concerned they are now being taxed twice. Once at the time of receiving the income and secondly when withdrawing this dividend income as part of their individual pensions. This is of course double taxation which is seen to be unfair and which most tax systems try very hard to avoid. This double taxation did not happen by accident, it was deliberately introduced by Mr Brown.
Mr Brown and his Labour colleagues ought to take responsibility for this attempted sleight of hand. They knew it would be costly to people saving for a pension but they thought it wouldn't be readily understood and they also calculated that it would be highly beneficial to the exchequer. It may well turn out not to be so highly beneficial to their reputations.
Yours sincerely,
Bryan Meeds
Dear Mr. Meeds, Thank you for your letter. Yes, indeed; I agree with what you say.
ACT mechanically works the way you describe. However, its purpose is to act as an imputation tax system so that dividends are not taxed twice. Hence the crediting of it to the pension funds. The ACT mechanism is in fact quite unnecessarily obscure and complicated- and has predictably led to general confusion.
Both Lamont and Brown were guilty of stealth and the reintroduction of extra tax on 'unearned income'.
yours sincerely,
Patrick Minford
Whilst I absolutely agree with every word you say about the effects of the abolition of the imputation system, contrary to what you say, the abolition of ACT did not give rise to the tax credit issue. It was the abolition of the imputation system. There is no requirement to have advance tax payments in order to maintain an imputation system.
James Manning
Dear Mr.Manning, Thank you. But ACT was the means by which the imputation was carried out. Thus its abolition effectively ended imputation except where a tax credit continued to be given (as for individuals). In principle of course you are right that there is no need to use ACT as the way to deliver imputation.
yours sincerely,
Patrick Minford