Finance Bill

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Dawn Primarolo: I read about this specific point during the lunch break, but I cannot remember the answer to the question that I thought the hon. Gentleman might ask. Because of the complexity of the system, Mr. Gale, perhaps you will allow me to answer the question when we discuss the next clause, to which the question is also relevant. I do not want to avoid the question and do not think that I shall be allowed to.

Question put, That the amendment be made:—

The Committee divided: Ayes 9, Noes 14.

Division No. 2 ]

Bercow, Mr. John
Chope, Mr. Christopher
Davey, Mr. Edward
Field, Mr. Mark
Flight, Mr. Howard
Hoban, Mr. Mark
Jack, Mr. Michael
Luff, Mr. Peter
Pugh, Dr. John

Boateng, Mr. Paul
Casale, Roger
Cruddas, Jon
Cunningham, Mr. Jim
Curtis-Thomas, Mrs. Claire
David, Mr. Wayne
Luke, Mr. Iain
McKechin, Ann
Marris, Rob
Pond, Mr. Chris
Primarolo, Dawn
Ryan, Joan
Southworth, Helen
Sutcliffe, Mr. Gerry

Question accordingly negatived.

Clause 31 ordered to stand part of the Bill.

Clause 32

Corporation tax starting rate and fraction for financial year 2002

Question proposed, That the clause stand part of the Bill.

Mr. Davey: I did not participate in the previous debate on incorporation because my comments are particularly relevant to clause 32. Some of the comments made by the hon. Members for Arundel and South Downs and for Fareham apply in spades to this clause.

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The Government propose to cut the starting rate of corporation rate from 10 per cent. to 0 per cent., thereby increasing significantly the existing incentive for sole traders and self-employed people to incorporate. It is a huge increase in that incentive. I want to develop the argument and speak about the potential cost of the tax revenue lost. Calculations by the Institute for Fiscal Studies, and indeed a report in yesterday's Financial Times, suggest that the costs may be much larger than those estimated in the Red Book, so the debate is particularly important.

I shall begin by clarifying what is going on. At the moment, people have to choose between being self-employed and paying income tax on their profits and national insurance contributions at a reduced rate, or incorporating to create a company of which they are the only shareholder and employee, in which case they pay tax as normal on their salary and pay out profits to themselves in the form of dividends on which they may or may not pay corporation tax. [Interruption.] For the record, we can hear some interesting noises but I think that we are safe.

The measure will significantly change the tax question of whether to be self-employed or to incorporate. To illustrate that point with an example, by setting up a company a person would be able to pay themselves a personal allowance of £4,615 against income tax, and on top of that make profits of up to £10,000, which would be paid out in dividends, while facing no tax liability. As a result of the clause, a person who incorporates could earn £15,000 and pay no tax. Labour Members may want to reflect on the distributional issues raised by the measure.

The cost of the measure is relevant because the Committee is concerned with protecting the taxpayer. The Government have estimated the cost of the measure and, as I said in my brief intervention in the previous debate, that has been aggregated with the measure on the small companies tax rate in the figures that I read out previously. It is not clear, although I am sure that the Paymaster General will clarify this for us, what the Government estimate the cost of the specific measure to be. Assuming for the sake of argument that the cost of the measure is the whole of the figure in the Red Book—which is a heroic assumption, but let us make it—by 2004-05 the Government estimate that the cost would be £450 million. I should be interested to know how they arrived at that figure, or a lower figure of which the Paymaster General is about to inform the Committee.

I should particularly like to understand the assumptions about the number of corporations that will benefit. Have the Government assumed that that will consist of the current number of corporations because there will be no behavioural changes as a result of the measure? Have they made an assumption about an extra tranche of self-employed sole traders who will decide to incorporate? Have they assessed that in arriving at their estimates? If they have, how many sole traders do they estimate will incorporate?

As the Committee scrutinises the Government's policy, it is important to see whether they have got those estimates right. I want to dwell on that point

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because of the work done by the Institute for Fiscal Studies. Through its analysis of the survey of personal incomes 1998-99, it says that 1.2 million self-employed people each stand to gain in excess of £500.

3.24 pm

Sitting suspended for a Division in the House.

3.39 pm

On resuming—

Mr. Davey: Before we broke, I was saying that I was concerned that the Government's estimate of the cost of the measure was an underestimate. I was using an analysis prepared by the Institute for Fiscal Studies to back up my case. The institute had established that 1.2 million self-employed people stood to gain in excess of £500 a year if they incorporated following this measure. One might ask why it chose that figure. My guess is that it decided that that was a large enough gain to act as an incentive, in conjunction with the other incentives in the system. I am told that it is possible to incorporate at around £100, although I am not suggesting that everyone can incorporate at that low figure. Many other considerations are involved in such a move, as we discussed in the previous debate, not least the hassle and time of going through the process, but they are one-off costs. The clause relates to a one-off gain—a permanent gain in the tax system. Therefore, if anything, the IFS was fairly conservative in its choice of 1.2 million self-employed who might be attracted by the measure.

The IFS tries to calculate the cost if 50 per cent. of the 1.2 million self-employed were to incorporate following the passing of the Bill. It estimates that the cost would be £1.2 billion, compared with the highest possible figure from the Government so far of £450 million. The institute also produces other costs estimates. If 75 per cent. of the 1.2 million self-employed who stand to gain more than £500 a year were to incorporate, the cost would be £1.9 billion; and if everyone in this community of 1.2 million self-employed were to incorporate, the cost would be £2.5 billion. That is the IFS estimate.

I am sure that the Paymaster General will agree that the Institute for Fiscal Studies is an independent and much esteemed body, which provides a great deal of useful research for our debates in this place. She may tell the Committee that its figures are incorrect and that it has got it completely wrong or that it has made a mistake in its methodology.

Roger Casale (Wimbledon): The hon. Gentleman seems to be developing an argument based on the idea that, if we implement a certain tax measure, everything else will stay the same, but one must not assume that what in this case is a gain for self-employed people is necessarily in the longer term a loss to the Exchequer. The point of the measure is to promote enterprise and business, which will in the longer term lead to greater revenues and lessen the loss to the Exchequer from the immediate impact of the measure. Surely the hon. Gentleman will accept that the tax might have dynamic effects as well as an immediate impact.

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Mr. Davey: I cannot have explained myself fully enough. There will be no extra economic activity as a result of sole traders deciding to incorporate. It has no effect on the country's overall economic growth; it is simply the result of a tax change. Therefore, it is a net loss. There is no extra growth or economic activity to set aside, unless the Government are about to tell us that they have changed the laws of economics, but I doubt that the Paymaster General will tell the Committee that.

Therefore, I disagree with the hon. Member for Wimbledon (Roger Casale). As far as I can see, the result is simply a net loss, which is what the Government estimate. My quibble is that the Government have made an underestimate, and that the Committee is being asked to agree to a tax measure that will cost the Exchequer far more than they think. It is incumbent on us to think carefully about that and probe the Government in case they have got it wrong. There is time to change, and to avoid money for our public services being lost.

3.45 pm

Mr. Iain Luke (Dundee, East): I take the point that sole traders may move in that direction, but people who operate in the black economy may also see the advantages of becoming legitimate and incorporated. Those people would benefit the Exchequer in a way that they have not done in the past.

Mr. Davey: That is a valid point, but not one against the thrust of my argument. I doubt that the Government's estimate took into account a reduction in the size of the black economy—the Paymaster General may prove me wrong.

I am going on the estimates of an independent body that is well renowned and well respected. It has considered dynamic changes, but not of the nature that the hon. Member for Dundee, East (Mr. Luke) suggested. The IFS considered the number of self-employed people available, the new incentive that could change their behaviour and move them towards incorporation, and what would happen if many of them took up that incentive. The IFS is describing not a static, but a dynamic picture. I want to probe the Government on whether they feel that their sums are wrong.

I will shortly conclude so that the Paymaster General can enlighten the Committee. If the Government are wrong, I would prefer it if they admitted it now. This is not about political point scoring but ensuring that the Exchequer gets the money it expects. If the IFS is right and the Government are wrong, we could see a questionable use of taxpayers' money—the hon. Lady would probably agree unless there is a policy objective that we have not heard about. Perhaps the Government want to give a lot of money to a certain group of people but have not got round to telling us. If that is so, we should debate whether that would be a sensible use of taxpayers' money.

Should the favoured group be in the business community or the community as a whole? Perhaps there is a policy objective for a group of businesses, but

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does the clause address the best way in which to target money? Perhaps extra allowances should be given to the self-employed so that they do not have to tinker around with incorporation and can just receive money. However, perhaps the Government feel that incorporation has extra advantages for the wider economy, but will not tell us about them. Given the Paymaster General's response in the previous debate, I would not be surprised if she said that the Government were neutral on the issue. I do not believe that such declared neutrality is exhibited in the clause.

Distributional issues are related to the clause. When business people heard the Chancellor on Budget day, they must have thought, ''Great! Here's a pro-business measure.'' Labour Members should be aware that it could mean a huge tax cut for a particular group at a cost to the wider community, and that that could cause distributional issues. I shall remind them of the figures that compare a self-employed person with an employed person, each earning just under £15,000 under the regime. The self-employed person pays no tax, and the employed person pays—I am told by the Institute for Fiscal Studies—£3,827. That is a huge difference, which I am not convinced that Labour Members want.

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