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Lord Marsh: Hear, hear!

Lord Cockfield: I entirely agree, but I shall not go into that. We adopted the imputation system because at that time we were on the verge of joining the European Community, and it was thought, mistakenly as it proved, that the imputation system would become the general tax system in the European Community, and it would therefore be to our advantage to adopt that system. The French imputation system does not tax dividends twice. It taxes them once and once only. Unfortunately the system is opaque and difficult to understand and its results are often misinterpreted.

The story must go on to Mr. Norman Lamont. Mr. Lamont was obsessed by a problem called surplus or unrelieved advance corporation tax. Incidentally, he did a great deal of consultation, so I am not criticising him on that ground. As a first step to meeting the problem of unrelieved advance corporation tax, he reduced the credit given to the shareholder for the tax already paid on the dividend from 25 per cent. to 20 per cent. It is a peculiarly warped piece of logic to say to A, who complains that he is paying too much tax, that it is the intention to increase the tax on B and then to point out to A how much better off he will be because, while the tax is being increased on everyone else, it is not being increased on him.

From the Treasury point of view, that manoeuvre has the great merit of raising an additional £1 billion of revenue. But the truth of the matter is that it was the first step--and a big step--back towards the Harold Wilson system of the double taxation of dividends. It is quite incomprehensible how a Conservative Government could ever have done that or ever have allowed their Chancellor of the Exchequer to do so. I can imagine only that the Government never understood what was going on and most certainly Mr. Lamont never understood what was going on. The argument recently advanced that it was the first step towards a basic rate of income tax of 20 per cent. is complete nonsense. It is not borne out by any of the documentation at the time and nor as a matter of logic does it hold water. It was done solely in the mistaken opinion that it would help the problem of surplus advance corporation tax and that on the side it would produce £1 billion of revenue.

Mr. Gordon Brown has now built on that and effectively he has reverted to the Harold Wilson system of the double taxation of dividends. The move has been disguised by transitional provisions and by measures to soften the blow on individuals. The picture is further obscured by the fact that the first victims are tax exempt bodies. Therefore, it appears merely to be an attack on the pension funds, but it is not. Ultimately, it is an attack on all of us and the day will come when that is apparent.

It is a massive return to the economics of old Labour. The economic arguments are bogus. The Harold Wilson system failed to deliver the alleged benefits. A quarter

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of a century on it will fail again. In the end, even the Exchequer will lose. Professor Northcote Parkinson's fifth law was:

    "Expenditure will rise to match the revenue available".
The £5 billion of extra revenue which will be raised by this manoeuvre has been mortgaged in advance in expenditure commitments. Mr. Gordon Brown is already hard at work digging his own grave. I hope only that we do not fall in it with him.

2.11 p.m.

Lord Marsh: My Lords, the noble Lord, Lord Cockfield, rightly drew attention to the failure of the Government to consult on many issues. That was a direct result of a totally unnecessary rush towards a Budget. It was part of the "Gung ho, let's show we are hitting the ground running" attitude. No doubt the Government were clearly inhibited by that failure to take advice and consult on a range of complex issues. I agree with the noble Lord, Lord Cockfield, that in respect of pensions, to which I shall return in a moment, the consequences will go much further than pensioners and pension funds.

Following a distinguished tax expert, I wish to begin with a few words in praise of income tax and those who administer the system. I must admit that I do not like paying it, no doubt like many other Members. Indeed, I spend a considerable amount of money and time seeking to avoid paying it. But it is efficient, flexible and, above all, fair.

However, in the Budget the Government did something which I cannot remember any other government doing. For purely electoral reasons they completely ruled out the use of income tax, despite the high cost and radical nature of some of their policies. I am pleased to see that at least one other noble Lord, hot from the Cabinet Room, has joined the noble Lord, Lord Ezra, on the Liberal Democrat Benches. Before they sold their souls for a seat in the corridors of Downing Street and an occasional trip in a government Mondeo, the Liberal Democrats spoke out consistently against that policy as being purely an election gimmick. They were right. It makes no sense for a government to write out of consideration the possibility of using direct personal taxation as one of the tools available to them.

They were completely committed, despite that, to very expensive policies, some of which are of very doubtful efficacy. Everybody feels the need to do something for the unemployed, in every country. The one fact that has become crystal clear over the years is that not very much is achieved by throwing money at the problem. But the Government were elected on those policies, and I hope very much to be proved wrong. However, even in that regard what they seek to do is marginal.

The Chancellor then took a calculated view that he could get away with the windfall tax and the abolition of tax credits because the public simply would not understand the implications. The windfall tax was presented as part of the crusade against the so-called fat

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cats--vastly over-paid people of little value to society, the sort of people who can be found on a No. 10 guest list.

Of course, the reality is different. That belief that there are things called companies which can be plundered and that that has no impact on people is a mixture of ignorance and a deliberate attempt to mislead. Companies do not have any money of their own. A tax on the utilities is a tax on their owners, otherwise known as shareholders. Those shareholders are not the rich.

There is a lot of mythology in the Labour movement about money, the City and large companies. Overwhelmingly, shareholders take the form of pension funds, insurance policies and particularly in the case of the utilities, the privatised companies, a very large number of small, individual shareholders. The majority of the individual shareholders uniquely in the privatised industries have an average shareholding of something like £2,000. That is because those people invested in the privatised companies precisely because they believed that it was safe because it was government sponsored. They invested at the invitation of the British Government in a public flotation. Some years later, the present British Government decide in retrospect that the issue was under-priced. They then say, "On the basis of that, the profits are too big". They say it is a one-off, but it will not be because those things never are once the door is opened. In deciding in retrospect, that the issue was underpriced they reneged on the original deal and sequestrated some of the shareholders' funds.

It will not be disastrous because of the sheer size of the companies. But it is a very dangerous precedent when people invest in a prospectus, particularly a government-backed prospectus, and then find that the basis upon which they bought is subsequently changed.

Of course, it is perfectly legal. The Government have a very large majority. With that majority, they can do virtually anything they like. But that is the commercial morality of a banana republic and not in the interest of this country.

The issue of tax credits is different. The implications are very wide indeed. As the noble Lord, Lord Cockfield, said, they go a great deal further than pension funds and the impact is as yet unknown. Being charitable, I do not believe that the Government knew what they were doing when they took that action. I am not sure that that is a particularly flattering remark to make about a government. They go down that road and then say, "Well, we did not consult so we do not know what is actually going to happen but we will do the best we can". That is extremely worrying. The implications are wide and still unquantifiable.

The basic facts are clear. That measure will have a major, wholly adverse impact on 7 million personal pension holders. I do not believe that anyone disputes that view. The noble Lord, Lord McIntosh, has said that it will get a lot better in the future. I must say that I have fired sales people for selling policies on that basis. However, it is generally accepted that the figure will be 7 million people or thereabouts.

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With the greatest respect, it is simply absurd to claim that it can be other than highly damaging to that very high number of ordinary people. William Mercer, a well-known firm of independent consultant actuaries, has published its first considered judgment. It estimates that the effect on personal pensions will be about 0.75 per cent. That does not sound very much, but the reality is devastating. For example, for someone with 20 or 30 years to go before retirement, it means that he would have to increase his contribution by between 20 per cent. and 30 per cent. to get there. It is not a question of choice. Most people will not be able to do it. If the Government did not know that that would be the effect, they should not have done it. That is not a piece of political propaganda; it is actuarial arithmetic. You do the arithmetic and that is the result. It is nowhere near as complicated as people outside the industry believe. I feel that I should declare an interest as I have a direct financial interest in the pensions industry and in the investment industry, which I have declared before.

The problem goes even further. The noble Lord, Lord Clark, mentioned the likelihood that employers would switch out of final salary schemes to the disadvantage of the people concerned. Arthur Andersen, another professional independent firm of consultants, decided to take a look at the matter. It surveyed 50 companies in the FTSE 350, employing over 500 people. That is not arithmetic; it is people's replies to a questionnaire. In response, two-thirds of them said that, as a result of the change in the tax credit position, they had already decided to move from final salary schemes to money purchase schemes. Moreover, 6 per cent. said that they were considering getting out of employee pension schemes completely. Again, that is not guesswork: those were the answers obtained from a questionnaire sent out by a reputable, internationally-known firm.

I could go on, but the effect on millions of people who are trying to provide for their retirement is massive. Many who left SERPS--with a lot of prodding from government--now find that they are worse off than if they had remained in it. The implications are interesting. If one looks at pension mis-selling, although it is different, it is clear that the people who mis-sold pensions knew, in most cases, what they were doing and should suffer as a result. But the government of the time, to give them the benefit of the doubt, did not know what they were doing. So some people deliberately chose particular pension schemes because they thought they were better than SERPs. They then contracted out of SERPS and into the other schemes, only to find that they would have been a lot better off if they had stayed with SERPS. I shall return to that point. It is retrospective mis-selling of pensions in a big way by government.

There is also a problem with local authorities and their pension schemes. They now find themselves in a special position. The noble Lord, Lord McIntosh, quite rightly said that, because there has been no consultation and no time to work it out, no one knows what the final position will be. That will come out in the actuarial studies. Therefore, no one knows what the cost will be,

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but obviously local authority finance directors have to make estimates. They may be wrong; but they have made the best estimates they can.

In that respect I give a few examples. These are the estimates drawn up by professional people acting in their professional capacity to the best of their ability. The figure for South Yorkshire is £7 million, for Merseyside it is £9 million and for Greater Manchester it is £10 million. One could go right down the list of unbudgeted expenditure which is now facing local authorities. I believe that they will have just three ways of dealing with it. One is to reduce staff, another to reduce services and the third way is to increase local taxation. These are different policies which are perfectly legitimate in different circumstances but they are not consequences that should arise by accident as a result of major legislation.

The Government's official line on this shambles is extraordinary in its naivety. There is no time to discuss the technicalities. The noble Lord, Lord Desai, said that there will be a switch out of equities into gilts. Some Members of the Government see that as a good thing because they are worried about the risks posed to carefully managed pension funds by equities. Of course that switch helps the gilts market. However, the moment one helps the gilts market, the value of gilts rises and immediately the yields fall. People in pension schemes have to invest their pension funds in gilts because they have to buy an annuity. Therefore, overnight, they will receive lower returns. People believe that the financial services industry is immersed in impenetrable mystery but it is simple. It is not a matter of opinion, it is a matter of arithmetic. When prices go up, yields come down. When yields come down, those people who have invested achieve a more profitable capital position and a less profitable income.

Most pension funds are primarily directed towards income. However, mature funds will have as great a concern with capital. The idea of a government wandering around this minefield, taking a decision and then saying, "Whoops, look what happened here we did not think that was going to happen", is terrifying. There is no doubt at all that what the Government expect to see happen is most unlikely to happen. They believe that that which is crystal clear to them is not even dimly apparent to companies such as Shell, ICI, Glaxo and the major R&D companies. They have not noticed that they should spend a little more on investment. The Government will not only tell them that they should do so--all governments tell industry what it should and should not do--but will try to force the position to make that happen. I do not think that it will happen and there is no evidence that it will.

This Government include people who are highly respected in local government, academia and the law. They are people of real talent who have good reputations. However, it is a fact--this is not intended to detract from their skills and achievements--that few of those people have any experience or interest in business or commerce. This Government do not have a Harold Leaver or a Jack Diamond. I am sure the noble Lord, Lord Barnett, will not mind when I say that they do not have a Joel Barnett.

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The culture of the Labour Party has always been suspicious of the Stock Exchange and its activities. Words such as "gambling" and "casino" are regularly used. Yet within days of entering office the Government concluded that they should go ahead with their policies in this area. As a result they have dealt a blow to the pension plans of 7 million people, far greater than Maxwell and mis-selling combined. The side effects are massive. The Government have become involved in trying to directly affect the share market and Stock Exchange. Yet I have heard it said--I am sure that it is not true--that some of them believe that P/Es are little green things served with fried cod. If the Government are working in this way, it is a terrifying prospect. They will live to regret it. The tragedy is that many people who were not responsible will pay the price.

2.30 p.m.

The Earl of Longford: My Lords, it was said, I believe of the late President Kennedy, that he may or may not have been a good president but he was a hell of a speaker. Rising above party controversy, I believe that we can say that about the noble Lord, Lord Marsh. My mind goes back to the time when he was an infinitely promising youngster. He sat beside me in the Wilson Cabinet. To adapt a phrase used of Gladstone, he was rising over the stern unbending socialists. I do not know whether the noble Lord feels that he still says the same thing, or has changed totally. I visit prisons a lot, and murderers and people say to me that they feel remorse. Does the noble Lord feel remorse at having been such an ardent socialist? I do not know. Perhaps at some time he will tell us. However, he speaks with enormous feeling and, frankly, it makes a strange impression on me, his old colleague and admirer on that Cabinet Bench all those years ago.

I shall detain the House for a very few moments. I have a question to put to the noble Lord, Lord McIntosh. I am glad that he is not totally inhibited these days. I should have much liked to have seen him playing a large part on the penal front, but he seems to have a mixed sphere of influence. I have given him notice of my question, and told him that I do not expect an answer or a comment. I hope that he will lay my fundamental and unavoidable question before his colleagues today. It is not a question which would have puzzled the noble Lord, Lord Marsh, in the old days. He would have given a very positive answer.

In recent times I have said that this is the most critical moment in the penal history of this country. I adapt the language a little to talk about our social history. This is the most critical period in our social history.

At the last election, I put to an excellent candidate this question. Does the Labour Party still believe in the redistribution of wealth in favour of poorer classes? No one can fail to understand the question. In the old days no Labour Government would have had any difficulty in answering the question. Certainly the noble Lord, Lord Marsh, would have had no difficulty in the days when he sat beside me.

That is my question. I realise that there are arguments the other way. I have changed; we have all changed over the years. The Catholic Church has changed. Some time

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ago we had Vatican II. I am not against all change. I do not suggest that. Nevertheless, when I was a young Conservative, working in the Conservative Research Department, an article in The Times said that unfortunately wealth is like heat. It is only when it is unequally distributed that it can perform what the physicists call work. I quoted that with alacrity. I probably supplied it to Mr. Neville Chamberlain, my chief, as a useful piece of spokesmanship. That was and remains an argument. It convinces many good people, better people morally, I dare say, than me. It convinces Christians, including, I am sure, the noble Baroness, Lady Thatcher, a good, Christian woman. The argument is plain enough. If one allows people to receive the rewards of their commercial activities, that will benefit the poor in the long run. Some people call it the "trickle down" theory. Whatever it is, the theory is extremely prominent throughout the world. People are allowed to achieve something and are rewarded, and in the end the poor benefit more than under any attempt at redistribution.

Whatever answer is supplied, we cannot get away from the question: do we favour redistribution towards the poorer classes and an increase in social justice? Looking back at the history of this country, roughly speaking, half of the 34 years preceding 1979 were under Conservative rule and half under Labour rule. During that period the income and wealth of this country were redistributed in the direction of the poorer classes. Then Thatcherism came in and there was an abrupt change. That change continues to the present day. It represents a redistribution of wealth in favour of the rich.

I saw some figures the other day, although I do not lay too much stress upon them, indicating that over the past 10 years the income of the poor has remained roughly the same; whereas the very rich have become far richer. Now, that trend is established as a fact. Do we in the Labour Party support that trend? Or do we return to the traditions of the Labour Party? It is a simple question. I do not ask it of the noble Lord, whose heart is in the right place, if my saying so does not embarrass him.

I am always nervous of paying compliments to Ministers since it might damage them. I may have fatally damaged the career of the noble Lord, Lord Marsh, by suggesting that one day he would be Prime Minister. I said the same of the noble Lord, Lord Mayhew, and it did not do him any good either. I am not sure that that was not what ruined the prospects of the noble Lord, Lord Marsh, as a future Labour Prime Minister. So I shall be careful. Subject to the reservations mentioned, the noble Lord, Lord McIntosh, has his heart in the right place. Today he is a government spokesman and bears that responsibility. Having been a spokesman of one sort or another in this House for over 20 years, I know how careful one has to be. One cannot speak as one would perhaps wish to do if one were on the Back Benches. So I do not expect an answer today. But there is the question. It cannot be escaped.

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As I understand it over the next two years we are more or less committed as a result of election pledges not to spend more money on welfare. So be it. We have gained a tremendous majority with a manifesto of that kind. I hope that we shall be in power for five years. After those five years are up and the next election comes, I hope we shall be able to produce a policy of which the late Clem Attlee would have been proud.

2.37 p.m.

Lord Butterworth: My Lords, I wish to spend a very short time drawing attention to a problem that is not dealt with by the Finance Bill. It was in a debate on 27th March 1996 that the noble and learned Lord, Lord Brightman, drew your Lordships' attention to the urgent need to simplify the rules governing capital gains tax. The introduction of self-assessment of income tax has increased the need to amend those complex procedures. I wish therefore to speak briefly about that problem.

Capital gains tax is an established and well-accepted tax whereby a capital gain is taxable above a certain level. The rules are complicated, largely because the gain is taxable, however many years it takes for the gain to emerge, provided only that it has emerged since March 1982 or from the date of purchase if the item was bought after March 1982.

Money has fallen in value since March 1982. Because it would be unfair to tax a gain that has emerged only as the result of a fall in the value of money, a device termed the "indexation allowance" was introduced into capital gains tax legislation. It is a device of Byzantine quality, about which I must go into some detail in order that your Lordships can appreciate the nature of the problem.

I think I can do no better than quote the pithy description of the indexation allowance given in that debate in March 1996 by the noble and learned Lord, Lord Brightman. He explained that, in order to calculate a capital gain, five steps have to be taken:

    "Step one: you deduct the retail prices index at March 1982, or at the later date of purchase, from the RPI at the date of sale in order to obtain an adjusted RPI. Step two: divide the adjusted RPI by the RPI at the date of purchase in order to obtain a readjusted RPI. Step three: you multiply the cost price of the investment by the readjusted RPI in order to obtain the indexation allowance. Step four: you add the indexation allowance to the actual cost price in order to obtain the adjusted cost price. Step five: you deduct the adjusted cost price from the sale price and there is your taxable gain".--[Official Report, 27/3/96; col. 1724.]
That is a Byzantine procedure which is clearly too complex for most who assess themselves and attempt to complete their tax return without professional advice.

The introduction of self-assessment of income tax carries the necessary corollary that the processes should be capable of being easily understood by all. In fact, the calculations can become much more complicated. Let me give an example. Every time there is a rights issue during the period when a share is held, the calculation must be repeated, as the RPI will be different at the date of a rights issue from that which prevailed when the share was purchased. Again, any investor who decides

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to take advantage of an offer of shares instead of a dividend needs to undertake the calculation at the time he receives the additional shares.

It has been suggested that much of this could be avoided if taxable capital gains were limited to gains made over the period of the past two years because the need for indexation might then be avoided altogether. If that is not acceptable, some other system must be devised which is capable of being widely understood and operated, not only by the man in the street but also by the peer on the Clapham omnibus.

2.45 p.m.

Viscount Trenchard: My Lords, first, let me say how much I have enjoyed today's debate. I am indeed grateful to the noble Lord, Lord McIntosh, for introducing it today. I have learned a great deal from noble Lords far more experienced and knowledgeable than I am. I am indeed grateful to your Lordships for your kind attention.

Not all noble Lords will agree with everything that Her Majesty's Government have done since taking office and some may share the concerns which are increasingly often heard nowadays; namely, that the Government are rushing through too much legislation without providing sufficient time for parliamentary debate. In that sense I worry that, intentionally or unintentionally, the role of Parliament, including that of your Lordships' House, seems to be being diminished.

Nevertheless, I appreciate the opportunity that we have today to debate the important matters contained in the Finance Bill. I also want to say how very delighted I was to learn today of the appointment of Mr. David Clementi as Deputy Governor of the Bank of England. I have worked as a colleague of Mr. Clementi for 20 years and have the very highest regard for him.

I must admit to a degree of disappointment in the Chancellor's Budget speech. It does nothing to alleviate the real economic problems that we face. At a time when there is a growing need for measures to encourage savings rather than consumption, it is to be greatly regretted that, instead, the Government have adopted measures that will discourage savings.

I do not want to talk today about the windfall tax, on which much has already been said in your Lordships' House and elsewhere. But in that connection also I believe that the Government hit the wrong target, as was so eloquently and clearly explained by the noble Lord, Lord Marsh. The windfall tax will do nothing to encourage investment by overseas as well as domestic investors in United Kingdom equities.

My noble friend Lord Mackay of Ardbrecknish told your Lordships that pension funds will no longer be able to reclaim the 20 per cent. advance corporation tax credits. The abolition of those tax credits means that tax exempt institutions effectively will be subjected to a 20 per cent. tax charge on their dividend income from United Kingdom companies, which would have to increase their net dividends by 25 per cent. in order to provide the same return as they do now to pension funds

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and to charities. The latter will benefit from a 2-year grace period and then some compensation on a declining scale for the next five years.

I understand that 19th April this year was designated Pensions Day by the Labour Party's campaign team. Mr. Tony Blair, at the time Leader of the Opposition, said in a pensioners' rally in London that day:

    "My message is be warned, your pension is not safe with the Tories".
Look what happened! The Secretary of State for Social Services is quoted as having said that the pensioner deserves a better deal. The Chancellor, to the contrary, has dealt him a severe blow.

The Chancellor's measure will encourage consumers to spend rather than save for their retirement. It is the opposite of what the economy now needs. Furthermore, it makes investment in United Kingdom equities relatively less attractive than before compared with investment in other kinds of assets, such as fixed income securities and foreign equities. That may well lead professional fund managers to reduce the proportion of pension funds which is invested in UK equities. That proportion is currently around 55 per cent. in a typical case.

Your Lordships will understand that the effect on share prices will be to reduce the prospects for capital gains at the same time as increasing the cost of capital to British companies. Pensioners may, therefore, find that not only is the dividend income of their funds reduced but that the capital value of their funds is also adversely affected, a so-called double whammy. That is from a government which have pledged to advance the long-term interests of the many and meet the people's priorities.

The Institute for Fiscal Studies has said that one would have to be very optimistic to believe the Chancellor's claim that the abolition of dividend tax credits will actually boost investment. I think that the Chancellor does not pay enough attention to the relationship between yield and value. Neither, apparently, does he recognise the relationship between share price level and ability to invest. The effect of his proposal will be to divert £5 billion a year from investment into government expenditure.

I should declare my interest as a trustee of the Royal Air Force Benevolent Fund. In the year ended December 1996 we were able to disburse £12.5 billion as direct charitable expenditure. This is money that is provided to former and current members of the Royal Air Force and other countries' air forces that fought with us in the Second World War, such as the Polish Air Force, in relief of sickness, disability, accident, infirmity, poverty or adversity. Our calculations show that for the year 2004 our main fund, together with its principal subsidiary funds, will suffer a loss of income of nearly £1 million as a result of the Chancellor's measures. This calculation assumes no increase in dividend payments during the period, so I believe the real loss will be much greater. The situation is the worse because investment income is our only increasing source of income. Our other principal sources of income--public support,

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Royal Air Force support and legacies--are all declining and are expected to continue to decline. I believe the other service charities face a similar situation.

It is also relevant that demands on the fund are increasing and will be nearing their peak at the time these changes take full effect in 2004. Nevertheless, I was happy to learn that the Government plan to review the taxation of charities and hope that this review may provide an opportunity to reimburse the losses that the charities sector will face as a result of the changes.

I am also a trustee of the Royal Air Force Benevolent Fund Staff Pension Fund, which will suffer an immediate annual loss of income of some £100,000. I believe therefore that the parent charity will have to suffer an additional burden in that it will need to increase its contributions to the staff pension fund by around 2 per cent. per annum in order to maintain the minimum funding requirements. Mr. Peter Murray, the chairman of the National Association of Pension Funds, was reported as saying that public and private sector employers will have to provide over £50 billion of extra pension contributions over the next 10 years, money which could otherwise have been used for investment. This works out at roughly £5 billion a year. However, this amount of additional contributions is what is needed to cover the shortfall in annual income. It is not the amount which would need to be added to the total principal amount of our pension funds now in order to maintain their dividend income stream.

The total pension fund pool in this country amounts to around £600 billion. Of this a little over half is invested in UK equities. Assuming no change in dividend payments, this amount would have to be increased by more than £75 billion in order for the current level of dividend income to be maintained. Alternatively, some companies may be able to increase their dividend payments. However, the Chancellor said in his Budget speech that the present system of tax credits encourages companies to pay out dividends rather than reinvest profits. I assume, therefore, that it is not through increased dividend payments that he intends that the income shortfall should be made up.

The Chancellor also reminded us that many pension funds are in substantial surplus and at present many companies are enjoying pension fund holidays. What he did not tell us is that around 40 per cent. of pension funds of quoted companies will not be able to meet their minimum funding requirements as a result of these measures.

The attack on pensions was an easy move for the Government to make because most people do not fully understand the advance corporation tax system. The Chancellor's move is perhaps easier to understand if one considers its effect on the heralded stakeholder pensions and citizens' pensions. Clearly, the abolition of advance corporation tax credits has substantially reduced the potential cost of a compulsorily-funded pension scheme as far as the Exchequer is concerned.

Unfortunately, the Budget introduces anomalies between different ways of saving, which is likely to lead to pension funds attempting to disguise themselves as

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personal equity plans or the soon-to-be-introduced individual savings accounts, in order to continue to receive advance corporation tax credits.

The reduction to 31 per cent. in the rate of corporation tax is, of course, welcome, but within two years it is likely that additional pension fund contributions will more than offset this benefit. The Budget has done nothing to address the structural imbalances within the economy. It has increased the incentive to spend rather than to save. It has made it more likely that there will be further interest rate rises leading to an even stronger pound. Against that background the prospects for our manufacturing sector maintaining its creditable export performance look increasingly bleak.

I must apologise for having detained your Lordships for too long. Other noble Lords have covered other aspects of the Finance Bill. I entirely agree with my noble friend Lord Mackay in what he said, especially on the subject of foreign income dividends, which is now causing so much confusion and uncertainty. I earnestly hope that the Minister will look again at the bitter blow that has been dealt to the country's pension funds and encourage his right honourable friend to reconsider his proposals in respect of advance corporation tax credits. I thank noble Lords for listening to me.

2.57 p.m.

Lord Lucas: My Lords, I would like to begin by answering a question which was asked by my noble friend Lord Mackay of Ardbrecknish in terms of Scotsmen changing their names. "Don't say Brown, say Hovis". That would be an insult to that great loaf in the context of this half-baked Bill which we have before us today, which has been improperly drafted and improperly considered--a strong argument for the Bill being considered in detail by this House. That is an argument which I believe will become unanswerable should the party opposite ever get around to reforming this House, as it has said it intends.

It is a Budget and a Bill which have brutal effects on industry. The noble Lord, Lord McIntosh of Haringey, quoted parts of the IMF report which approved of what the Chancellor had done. He left out the bits where it pointed out the damage to industry and suggested that consumers should have been more heavily taxed. I am very glad that the noble Lord, Lord Desai, was able to fill in those missing parts in his peroration.

I must do my best to adopt the non-adversarial and inclusive approach which is being hymned by the party opposite, and perhaps confine myself to the side-effects of this Budget, and to some words on the RPI, which has featured in many speeches.

"It's good to talk", as they say, and perhaps it would be a good idea if the Chancellor was to do some more of it, as my noble friend Lord Cockfield so admirably said. He should at least talk to his colleagues who have great plans for the economy and for the future of this country, such as the introduction of a new pension and social security system and a long-term approach to the way in which we look at investments. As the noble Lords, Lord Marsh and Lord Barnett, pointed out, it is

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no good talking about long-termism and then looking at the short term in all the measures that one takes. The Wood Mackensies of this world, when they look at pension funds, say that they are looking at long-term performance, but they measure it quarter by quarter and so long-term performance just becomes a succession of short-term performances and any real sense of long-termism goes out of the window. If the Chancellor does the same and measures all his activities by the short term, then long-termism will not have a look-in.

The Gladstonian settlement for the Chancellor has set him apart and made him an institution which is both adversarial and non-inclusive within government. It is something at which this Government, if they are true to what they profess, ought to take a look.

The Chancellor should have talked in particular to his colleague the noble Lord, Lord Simon of Highbury, who could have told him in a moment what a mess he was making with FIDS. Indeed, on the day after the Budget, BP wrote to the Chancellor telling him that if he persisted in that, it would list in Luxembourg and would no longer be part of the FTSE in London. Within the next few days, about a quarter of that index had similarly written to the Chancellor. That is the motivation behind his change of mind. If the Chancellor had had the sense to talk to anybody who understood anything about major companies, he would not have made that mistake.

The Chancellor could also have talked to Martin Taylor of Barclays, who could have told him something about the effects of the proposed tax changes to leasing. Leasing has, indeed, been used by banks as a tax avoidance scheme, but it is a tax avoidance scheme with excellent side-effects for industry. It has made cheaper, and has encouraged, investment in capital goods by British companies and at least half the cost of that so-called "tax avoidance" has gone into benefits for British industry. Barclays may look around for a month or two for other ways of sheltering from tax and it will find them because it has some excellent people on board. As far as I can understand what is being said at the moment, it will find such a shelter in schemes that will benefit overseas companies and individuals, not British companies. The net cost to Barclays will last for a month or two, but the net cost to British industry will be of the order of £0.5 billion per annum.

Martin Taylor might also have had something to say about the moves to stop market makers benefiting from dividends and providing liquidity to markets over dividend dates. If dividends are made so unattractive to people, tax avoidance schemes will be built around them. You cannot avoid that. Now that that incentive has been increased, more such schemes will spring up. Why choose to attack one of the main mechanisms of liquidity in the London market and allow the abuse to appear elsewhere?

There has to be an understanding of the fact that the tax avoidance industry will always be one step ahead of the Treasury. What the Treasury has to do is impose a morality and to make sure that people do not take it too far and that those abuses that occur are controlled and have beneficial side-effects. The windfall tax is a direct

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attack on any reasonable concept of morality between the Treasury and the taxpayer, particularly the corporate taxpayer. Its effect will be to push people into what perhaps I may describe as an "Italian attitude" of institutionalised tax avoidance and deceit. I should be very sad to find our tax system going down that road.

If the Chancellor had chosen to talk to almost anybody about his proposed changes to pensions tax credit, he would have been put right. So many noble Lords have referred to this today that I do not want to speak at the length that I had planned, but I am sad that my noble friend Lord Buckinghamshire is not here today because, as a professional, he would have been able to enlighten the Government on the way in which actuaries go about the business of valuing pension funds. They do it on the basis of income--and what other basis is there for valuing a share? It is all that the long-term shareholder ever gets from a share. When he sells, he does so to somebody who wants the income that is yet to be generated by that share. To do so on any other basis would be a form of pyramid selling. It is right to talk about market value, but market value is related to future income and the Government have cut both that and the actual income at a stroke.

The Government have also taken the unusual step of reducing the accepted value for the underlying growth rate of the British economy. It will be interesting to see how actuaries take that into account when they look at the prospective dividend growth rate in their pension funds.

Actuaries are being asked to swap the immediate certainty of dividend flows for an extremely sketchy uncertainty of the possibility of greater dividend growth in the future. That dividend growth is not due to come from anything that the Chancellor has done; it is due to come from companies further cutting the dividends that they pay in order to create money for reinvestment. That will merely compound the problem of pension funds and pension fund shortfalls. They are extremely unlikely to do it and I cannot see any benefit to companies from that move.

The Budget misunderstands the basic role of dividends, particularly if one is looking at tax-exempt funds and pension funds. Dividends are a mechanism for moving cash from cash-rich and cash-generating companies--from the cash cows to the young calves of Britain who require some food. Pension funds take their dividends and reinvest them in companies that need the cash. Now the cash will be stuck in companies that do not need it. One will have breweries with bulging coffers, but young high tech companies that we need for the future must turn elsewhere for it, because it will not be in the hands of the institutions that used to have it.

The Government have great plans for pensions. In making this move on taxation they have cut off many of their options and alternatives far too early. It would have been much more beneficial had they saved this change, should it have been made, until their entire plans for the pensions and savings industry had been in place. As many noble Lords have said, there will be a good number of side-effects, some unknown but some already obvious. There will be a gearing up of British

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industry. The pension funds will want to have back their income. Future issues will not be in the form of shares but in the form of convertibles. There will be leveraged buy-outs.

One of the extraordinary side-effects of this Budget is the possibility of windfalls for individuals. The Budget is supposed to be a response to the problems in the economy created by windfalls, but it has been done in such a way as to ensure that companies indulge in share buy-backs on a scale that has never been seen before. That will create yet further windfalls in the hands of those lucky enough to hold those shares. It will make the whole business of venture capital much more difficult because the higher risk end of equities will be the area from which pension funds will flee in their search for income. It will make pension funds more short term and industry more short term in its attitude. A company that is highly geared must have a more short-term attitude.

It will poison any movement there may be towards final salary schemes. It is perhaps more correct to say that it will hasten the rush away from final salary schemes. It will have an immediate effect on individuals who are to retire. An individual who retired a day before the Budget would receive 13 per cent. more in pension than an individual who retired a day after the Budget. If one looks at the effect of the measures, it is an immediate tax on those who are retiring. As the noble Lord, Lord Marsh, has said, this can be made up only by those of us who have 20 or 30 years to go by a 30 per cent. increase in contributions.

Further, it will make property companies a relatively unattractive investment. It will be 31 per cent. more expensive for an institution to hold properties through a property company than through direct investment. By and large, this means that the property market as a whole will become much less fluid, active and efficient. It will result in the movement of assets overseas where there is not the same disadvantage on the income front as there used to be. As the noble Lord, Lord Marsh, has said, it will lead to a move back into SERPS. To be in SERPS is now more profitable than to be out of it. That will cost the Government dear. It has been estimated that over time it may account for half the benefit that the Government hope to receive from this tax change. It will also impose on industry an enormous upfront cost in making up its pension schemes. Industry will gain no benefit from it unless it does what the Government supposedly urge it to do and cuts its dividends so that it has more money to invest. If it does so it will merely compound the problem.

But enough of what everyone else has said. I should like to deal now with the retail prices index. This has become an important part of our economic management. It is the target that the Bank of England sets, and it has been given only interest rates as a mechanism to meet that target. When inflation was running at 10 per cent. a year, errors in the RPI did not matter all that much. It did not matter if it was 1 per cent. or 2 per cent. wrong. The difference between 9 per cent. and 11 per cent. was not part of the public consciousness. However, when one speaks of an RPI target of 2.5 per cent. errors in the RPI matter a great deal.

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In March 1996 the Bank of England published a paper entitled Measurement Bias in Price Indices. That looked in particular at three sources of error in the RPI. It referred to outlet bias, because the RPI does not take account of the fact that people would look at various shops and choose to buy at the cheapest one. The movement from the more expensive to the cheaper shops is cut out of the RPI and so the RPI overestimates inflation. It is late in bringing in new goods. It waits until new goods have reached the plateau of their price progression. It misses out on the bit when they are dropping steeply in price, and, again, overestimates inflation as a result. It misses out changes in quality, as is occurring continuously with goods such as computers, and overestimates inflation as a result.

The Bank of England's conclusion was that the RPI, as a result of those three factors, might be an up to 1 per cent. overestimate of inflation. Things do not stop there. The RPI includes interest, as a proxy of housing costs. So if the Bank of England puts up the interest rate, it puts up the RPI. The Chancellor has fitted himself with a set of self-twisting knickers. He cannot do anything about it. The more the Bank of England sticks up interest rates, the more the inflation rate goes up, and, presumably, the more it has to stick up interest rates to try to bring it down again.

The RPI includes house prices as a proxy of house maintenance costs. That is ridiculous. In a period of high house price inflation as we have at the moment, maintenance prices have not increased by 25 per cent. in the past year. The RPI does not include the effect of loyalty cards, BT's friends and family scheme, and all the other schemes that organisations have to keep customer loyalty, which have greatly reduced the cost of shopping in places such as Tescos, and the cost of telephone calls. But those reductions are not in the RPI.

The family expenditure survey upon which the RPI is based is acknowledged to be unreliable. It has to be fudged for drinks, sweets and tobacco. If you look at the way in which the weights have changed over the past five years, it is supposed, under the family expenditure survey, that we have not spent a penny more on telephones. It is still only 1.5 per cent. of our expenditure. It is the same over each of those five years. But the amount we have spent on rail travel has apparently fallen from 0.6 per cent. to 0.4 per cent.

There are a number of other aspects of the survey which raise some eyebrows as to whether anyone has tried to connect what it is saying with the real world; whether they have compared the minutiae upon which it is based of innumerable surveys of shops and people with what is happening in the economy as a whole.

It includes indirect taxation. That is an extraordinary thing for it to do. The Chancellor taxes us indirectly through raising the price of cigarettes, and it is in the RPI. If he raises income tax, it is not. What is the argument for indirect taxes being in there? Why should we look at inflation in that way? It is not, it is taxation. There is an index published (the RPIY) which excludes that. Is that not the direction in which we should be going?

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There is nothing in the RPI for major elements of our expenditure on the NHS, education, or roads. Just because they are done through the Government, does not mean that they are not part of inflation as experienced by ordinary people. Certainly their effects are, because if we are getting inflation in those areas it comes back at us in tax.

We have to get the RPI right. It seems possible to me, on the basis of my quick look at it, that we might have an RPI inflation which is zero at the moment. We might be basing our entire economic policy in terms of interest rates on trying to get down an inflation which is already not there. We have to use a measure which is accurate. It is enormously important that the Bank of England should be running its interest rate policy on a measure based on reality.

In conclusion, I ask whether the Government will follow their own premises: to open up the process of setting a Budget; to apply the principles of inclusiveness and non-adversarialness to the way in which, internally, they generate their Budget decisions; to make a new settlement for the Treasury so that individual Ministers can take on more responsibility. They are asking the Scots to take on the responsibility for their own budget, but individual Ministers still do not have to live with the consequences of their decisions. They are treated by the Treasury as if they were babes in arms. There needs to be a more equal split between the responsibility for money taken by the Treasury and that taken by Ministers, hard though that might be for the Treasury to accept. It might also result in it coming a few centuries up to date in its accounting policies.

I hope that the next Budget, which is not long away, will support the long-term projects for the success of this country which the Government profess, and that it will rescue us from "Brown's bust", which seems to be the fatal result of this Budget.

3.15 p.m.

Lord McIntosh of Haringey: My Lords, the length of the debate and the expertise of those who have taken part give lie to the claim that your Lordships have had an inadequate opportunity to consider the Finance Bill. At the beginning, I was inclined to divide the debate into one about process--in other words, the consultation and other processes leading to the production of the Budget and subsequently the Finance Bill before us--and product, which I thought would be the content of the Finance Bill and its implications. I now see that my taxonomy was inadequate. There is indeed a process and I shall try to spend as little time as possible on it. There is also product--and I refer to the contributions which are related to the Finance Bill.

However, there is a third section which appears to me to have nothing to do with the Finance Bill or the subject we are debating today. I would love to follow my noble friends Lord Barnett and Lord Desai in their speculation about the way in which the economy is going. They know far more about that than I do and I am not qualified to do so. However, I am in no way capable of following the noble Lord, Lord Lucas, for example, who spent a long time discussing the retail

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prices index, or the noble Lord, Lord Butterworth, who spoke about the indexation of capital gains tax. Neither of those subjects had any connection with the Finance Bill which is before us.

I shall deal as quickly as I can with the issue of consultation and the nature of the process--

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