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There is an even more fundamental objection to the Lib Dem proposal—that it cannot be done. When Lord Turner’s Pensions Commission considered the possibility of scrapping higher rate tax relief on pension contributions, he concluded that as long as defined benefit pensions remain a significant part of our provision, in both the public and private sectors, it was not practical to abolish higher rate relief, because when an employer pays contributions into a defined benefit scheme he does not need to attribute them to individual scheme members. None of those contributions generates tax liabilities for an individual member of the scheme, so they simply go in as a contribution by the employer.
Under the Lib Dems’ proposals, every single employer contribution would have to be apportioned and a tax liability assessed for each member of the scheme. Even if that could be done, a greater problem would arise, where an employer makes up scheme deficits at the behest of the pensions regulator. In some cases, companies are putting in hundreds of millions of pounds to make up deficits in their pension schemes. Are the Lib Dems proposing that employees, who might be blissfully unaware that such contributions are being made to make good the deficit, should suddenly be landed with a tax bill for the contribution that had been paid on their behalf? The consequences of that are all too easy to predict.
The problem in the public sector is even worse. There is no fund, so there are no deficits, just a totally unfunded obligation that independent actuaries estimate at up to £1 trillion. How are public sector pension promises to be valued, and how is the cost of meeting them to be defined? Some public sector schemes already have notional employer contributions at a level of 27 or 28 per cent. of the total salary bill. If the calculation at individual level could effectively be made, NHS professionals, police officers, school headmasters, civil servants and others would be subject to a significant new tax charge on the contribution that the employer has made. That would shrink disposable incomes, and have a very understandable effect on long-term saving patterns. The proposal will not work technically, and if it did, it would have devastating consequences.
There is a big hole in the sums concerning the pension tax proposal, but what about capital gains tax changes? They risk resembling a cynical exploitation of the sense of outrage that has been whipped up by the media and the unions concerning the taxation of carried interests in private equity funds. In my party, we recognise the need for fairness in the tax system to maintain public confidence, and the Government’s amendment gets it right in its reference to the need for balance. Responsible politicians must be prepared to explain the dynamic effects of tax changes that may otherwise appear superficially attractive when presented in a static model. Ignoring the behavioural changes that can be expected to flow from a given tax change is to deceive as to the likely overall consequences. We must all be willing to argue the case for what is best for Britain’s economy, jobs and prosperity in the long term, even where that might mean resisting the temptation to change the tax treatment of a superficially tempting and politically vulnerable target.
Let me be clear: there is a case for looking carefully at the tax treatment of private equity. That is why the Conservative party has established a proper review of private equity and venture capital, including taxation treatment, which is being carried out for us by the European School of Management. Our objective in doing so is not to demonise an important industry, but to ensure that the tax treatment provided is appropriate to maintain the UK’s competitiveness as an environment for globally important business.
No one should be under any illusion that the delivery of a tax-competitive environment is some act of altruism directed at the operators of whatever business appears to benefit. It is, rather, an act of the utmost self-interest, and our objective, which I assume the Government share, will be to set the tax regime at exactly the point that optimises investment, maintains international competitiveness and maximises the return to the UK economy as a whole.
Julia Goldsworthy: I agree with the hon. Gentleman that there needs to be a point of principle rather than simply targeting or scapegoating a specific group. May I take it from his comments that the Conservative party will institute a review rather than, as the shadow Chancellor said a few weeks ago, support plans to raise taxes for private equity? Will he confirm that that policy will not go ahead and that there will be another policy review instead?
Mr. Hammond: The policy review is already under way. The European School of Management has undertaken to produce a report on the overall climate for private equity and venture capital in the UK, including the tax treatment of the sector.
Perhaps it will help the hon. Lady if I tell her that the shadow Chancellor has set out four tests which any reforms of the tax system must pass. First, they must not damage the competitiveness of the UK economy or the health of our financial services industry. We want Europe’s private equity business to be based here in Britain, providing jobs and prosperity for British people. Secondly, we should reward those who take genuine risks. Thirdly, the tax system should focus on rewarding long-term investment and, fourthly, any reforms should be part of our broad project to make the tax system simpler and fairer.
Leading figures in the industry have made it clear that, if something looks like income, it would be peculiar not to tax it as income, but if it looks like genuine risk taking and entrepreneurship, we should do everything we can to encourage it. One of the dangers, which the Chief Secretary mentioned, is that the original purpose of taper relief may get lost. It is a question of throwing out babies with bathwater.
Taper relief was introduced as an alternative to indexation to protect inflationary gains from inappropriate taxation and as an incentive to entrepreneurship and risk taking. We must ensure that changes that are proposed or discussed do not lose sight of that original incentive. The proposals that the Liberal Democrats included in the paper that they published last week would hit not only private equity houses but small-scale entrepreneurs and genuine venture capitalists who fund British start-ups. The abolition of taper relief and the reduction in the annual
allowance to £1,000 would have that effect. The hon. Member for Twickenham—I am glad that he is back in his place—said that that was not clear, but let us examine the figures.
When the Liberal Democrats published their paper last August, they said that the benefit to the Exchequer of scrapping taper relief would be £4.5 billion and that that of reducing capital gains tax allowance to £1,000 would be £1.7 billion. That is £6.2 billion altogether. However, in the paper that they published last week, they said that the benefit of scrapping taper relief—the hon. Member for Twickenham claims that that does not include the reduction of the allowance to £1,000—would be £6 billion. That is £200 million less than last August’s figures, which suggests that the tallied up benefit includes the reduction in the allowance.
Dr. Cable: The data on which we based those numbers came straight from the Treasury in answer to a parliamentary question and reflect the fact that the Treasury’s estimate of the yield from the tax relief on taper has greatly increased in the past 12 months. The figures are consistent—the Institute for Fiscal Studies was invited to review them and considers that they add up.
Mr. Hammond: If we are to understand that in the course of eight months the estimated yield from scrapping taper relief has increased from £4.5 billion to £6 billion, it makes me wonder on what I can rely in the overall equation that the Liberal Democrats have calculated. [Hon. Members: “They are the Treasury’s figures.”] We are, therefore, to work on the understanding that the Liberal Democrats have decided this July to keep the £8,800 annual allowance, which, last August, they intended to scrap. Fine. That is perfectly clear and I am grateful for that clarification.
Let me say something else to the Lib Dems about their proposals on capital gains tax. I do not know what the hon. Gentleman’s purpose was in publishing those figures last week, but no serious political party that has any expectation of shouldering the burden of government would ever announce such changes to the capital gains tax system in advance. If there was the slightest danger of the Lib Dem proposals being implemented, those who held assets that were pregnant with capital gains tax liability would be able to dispose of them ahead of any such changes. It would therefore be grossly irresponsible, as well as completely self-defeating, to announce a tax change of that type in advance.
Similarly, the swipe at non-domiciled residents—people who have little if any political clout, unless they are donors to the Labour party—lands a blow on an easy target, but the evidence does not support it. The Chief Secretary is looking rather shocked, but he will know that there is a case for constantly reviewing tax treatment of that sort, albeit not in a threatening or aggressive way, but simply to ensure that it produces an overall net benefit to UK plc, not just to the individuals concerned. As the hon. Member for Twickenham pointed out, the Government’s review seems to have been spectacularly ineffective, even by their standards. I
have to tell the Chief Secretary that when his party’s largest single donation of the year has come from a non-dom, suspicions about the management of that review are bound to arise, and he will have to deal with that.
However, the Government’s manifest failure to conduct a quite proper review of the issue effectively and efficiently does not excuse the Lib Dems’ announcement of a policy without researching the consequences. They claim that the proposal would increase the tax take, but at stake is £3 billion-worth of direct tax—the amount estimated to be paid by non-doms on income generated in this country or repatriated to the UK—as well as, potentially, a much bigger hit on the UK economy, as I am sure everyone would recognise, if a shake-out of the non-dom rules causes the relocation of control of significant operations from the UK to places outside it, as many in the City fear.
I am afraid that the Lib Dem numbers just do not add up. [Hon. Members: “They do.] They do not. The Lib Dems claim that the IFS has validated them, but we talked to the IFS to see what it had done. What it did was merely check the arithmetic on the basis of a static model. The IFS has confirmed that it would expect the dynamic effects—the behavioural changes that those tax changes would produce—to work against the Lib Dems. A few minutes of not particularly in-depth analysis blows a significant hole in the model, leaving, I am afraid, the hon. Member for Twickenham clutching a £22.2 billion spending commitment, with precious little of his hopelessly speculative tax-raising agenda left to cover it.
Before I sit down, it is worth noting for the record that if the Lib Dems’ numbers come from cloud cuckoo land, whoever wrote the Government amendment seems to be living on a different planet altogether. Try telling the thousands of families let down by the tax credits system or a business struggling to cope with the longest tax code in the world that the Government have undertaken a “comprehensive...reform” of the tax system; and tell it to the fairies that those reforms have “encouraged saving”, when our savings ratio is at its lowest for 47 years. Try telling the wealth creators and risk takers in small business the length and breadth of Britain that the Government have “rewarded enterprise”, when they have just raised the small companies tax rate and when they increased taxes on businesses by a total of £1 billion in the 2007 Budget.
The Liberal Democrats’ tax-cutting pledge is an unfunded spending commitment. The motion before us is intended to convey the impression that squeezing the wealthy—or the super rich, depending on which day it is—can pay for their proposed largesse, whereas the truth is that the measures targeted at that group will not produce anything like the sums required. As the documents produced by the hon. Member for Twickenham show, even on his own flawed assumptions, households with incomes of £46,000 upwards will be losers—
Dr. Cable: Sixty-eight thousand.
Mr. Hammond:
Single-income households with incomes of £46,000 upwards will be losers. I have a great deal of respect for the hon. Gentleman when he is
in analytical mode. He has correctly identified some of the issues, and the Government’s failure to tackle them, but in playing the squeeze-the-rich card rather than focusing on the urgent actions needed to allow those at the bottom of the income scale to participate in our rising prosperity, he has let the temptation to pander to popular prejudice triumph over a cool, professional analysis of what is in Britain’s best interests and what will deliver long-term, sustainable social justice.
9.15 pm
Steve Webb (Northavon) (LD): I congratulate the Chief Secretary to the Treasury on his promotion to the Cabinet. It was my pleasure to shadow him and the right hon. Member for Liverpool, Wavertree (Jane Kennedy) when they were at the Department of Health while that was my responsibility, and I wish them well in their work at the Treasury.
I had planned to expatiate on Liberal views on redistribution, to ask how one can propose freedom then take money from a group of people, and to discuss what the limits on that might be. However, as the Chief Secretary has been given such duff material to work with, I thought that I ought to respond to some of his points about the Liberal Democrats’ tax proposals.
The right hon. Gentleman seemed to be looking in two directions at once. He said two things about our plans. First, he said that our local income tax plans were evil because they would place a terrible burden on middle and higher incomes. He then said that our national tax plans were evil because they would give a disproportionate amount of money to the very same people. In other words, he was saying that cutting the basic rate of income tax by 4p would be dreadful because higher earners would gain, but putting local income tax up by 4p would be dreadful because higher income earners would have to pay more, and that was not fair. He cannot hold those two positions simultaneously. The Chief Secretary is a thoughtful man, and I am sure that he knows in his heart of hearts that he was given a bit of a duff text to start off with.
The Institute for Fiscal Studies, for which I worked for nine years, has often been cited in the debate. It has a view of how we should assess the distributional impact of tax plans: it says that we should look at the whole package, and not pick just one bit out. The whole package includes a national basic rate cut of 4p, and a local income tax of broadly equivalent measure to take the place of the council tax. So if the national income tax cut and the local income tax offset each other, the change would be nil.
The distributional impact of our tax policy would be to scrap the council tax—which is effectively a poll tax, especially for pensioners and the low waged—and to tax more the very wealthy, those who gain from higher rate tax relief and those who buy large gas guzzlers or are frequent fliers. Those categories of people are all predominantly wealthy. The principal beneficiaries would be those on modest incomes who are hit hardest by the council tax. That is what I call fair.
Andy Burnham:
I admire the hon. Gentleman’s ability to rewrite the Liberal Democrats’ tax plans on his feet at that speed. It was very impressive. May I
explain to him what I was saying? The analysis of the 4p cut in income tax shows that those in the top income deciles would benefit disproportionately from the plan. My point was that, for lower earners, a combination of that change, coupled with a local income tax, which would transfer the burden to those in work and away from those out of work, and environmental measures such as higher petrol taxes and taxes on flights—whatever he says, lots of working families take one, two or even three flights a year—would leave middle to lower-income families in work worse off. If he can disprove that now, I would be grateful.
Steve Webb: I am very happy to do that. I shall run through the elements in the package. Let us suppose, for the sake of argument and for ease of estimate, that the local income tax rate in a particular local authority is 4p. A reduction of 4p in the national basic rate of income tax would therefore equate to 4p going on to local income tax in a local authority area. The net effect of that has to be zero. I am sure that the Minister would accept that. The net effect of the national basic rate coming down by 4p and the local income tax going up 4p has to be nil. That change has nil effect.
We then need to take into account the effect of closing pension tax relief, which is by definition only available to higher rate taxpayers who must be better off; getting rid of the capital gains tax taper relief, which overwhelmingly benefits the better off; scrapping the council tax, which is a very regressive tax whose abolition will help the poor; and then imposing environmental taxes on people who buy large gas guzzlers, who tend to be better off, and on the most frequent flyers who on average tend to be the better off—all those are progressive changes. It is impossible to understand how the effect of that whole package can be anything other than progressive—the Institute for Fiscal Studies has demonstrated that the only group who lose out is the top decile.
Julia Goldsworthy: On replacing council tax with local income tax, there is no doubt that for many people in work but on low incomes, the council tax represents more than 4 per cent. of their income.
Steve Webb: My hon. Friend is absolutely right. If we reflect on the low paid or indeed pensioners on very modest incomes, the burden of the council tax is one of the most severe that they face.
Andy Burnham: As usual, the Liberals pick an easy target like the gas guzzlers or big SUVs and make them the whole focus of their tax policy, but is the hon. Gentleman suggesting that tax cuts on this scale could be delivered without substantially raising tax on petrol? Is he saying that everything can be loaded on to drivers of large four-wheel drive vehicles?
Steve Webb: The right hon. Gentleman said that he had spent the weekend reading our tax plans, but having heard what he just said, I am not sure that he could have done so. Our environmental package is based first on the taxation of flights. We want to tax emissions more heavily— [Interruption.] I will, indeed, answer the question. Some additional revenue comes from taxing half-empty flights. In other words, at the moment, air passenger duty is applied per passenger, but we propose to tax flights based on their emissions. Let me explain what that means.
The Chief Secretary mentioned his constituents who go on holiday, but many of them go on packed easyJet flights on which the air passenger duty is great because every place is used. What we propose, however, is heavier taxes on half-empty planes that are producing relatively more emissions. We should base the tax on emissions, not on individuals. We can therefore secure additional revenue in a more environmentally effective way from air passenger duty and further revenue from taxing air freight—another environmental bag from which revenue can be derived. We also want a more progressive system of environmental taxation on larger cars. Taxes should be levied on people who choose to buy larger, less fuel-efficient cars. That amounts to about a third of the total tax package.
My current role is to write my party’s manifesto for the next election and I have to tell the Chief Secretary that the criticism that the Liberal Democrat policy is not detailed enough is simply not one that I recognise. It is absolutely clear from what I have said that our package is a progressive one.
Let me say a few words about restricting pension tax relief to the standard rate, which the Conservative spokesman, the hon. Member for Runnymede and Weybridge (Mr. Hammond), mentioned. To give him his due, in the midst of a rather banal run-through of the shadow Chancellor’s four great principles, such as “tax changes should not be bad for the economy”—that must have taken a long time to write on the back of his envelope—the hon. Gentleman made some serious points about restricting the pension relief to the standard rate. He argued that that would somehow contribute to the pensions crisis. Excuse me, but it seems to me that the pensions crisis is not about higher rate taxpayers not saving enough—that is not where the pension saving gap is—but about women, part-timers and people on low and modest incomes who are not saving enough. How can restricting pension tax relief to the standard rate rather than the higher rate have any impact on the pensions crisis? There is simply no connection between the two. The pensions crisis relates to people on low and modest incomes not saving enough, but this tax change hits only the wealthiest. As the former shadow work and pensions spokesman, the hon. Gentleman will know that the very wealthiest gain disproportionately to a huge extent from pension tax relief.
Mr. Philip Hammond: Those comments are rather strange against a background of a record low savings ratio, but will the hon. Gentleman deal with the more substantive point that the idea of abolishing the higher rate pension tax relief is technically flawed?
Steve Webb: That point was raised by the Turner commission, but the hon. Gentleman has to accept the fact that pension tax relief must be allowed at some rate, so there is no reason why we should not set the rate at which it should be allowed. The whole system must be geared up to administer pension tax relief and we can set the rate at which it is allowed. If we set it lower than the higher rate, that has a simplification element: instead of different employees getting different rates of tax relief, they all get identical rates of tax relief.
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