Don't blame Brown for pension fund tax crisis
Stephen Beer says Labour should be proud of the Chancellor's 10-year stewardship of the economy and the responsibility for pension shortfalls lies elsewhere
Economic policy remains a key political battleground for Labour. Recent events demonstrate that well. A change in taxation, announced almost ten years ago, has become the subject of intense scrutiny. Labour has been on the defensive yet our management of the economy, through Chancellor Gordon Brown, is one of our strongest political foundations.
Following the publication of Treasury advice under the Freedom of Information Act, achieved by The Times, public debates held in 1997 have been revisited. Gordon Brown stands accused of ignoring civil servant advice and not being clear about why he abolished the pension fund tax credit on dividends.
The advice does not hide a ‘smoking gun’ that shows the Chancellor to have been duplicitous. It shows that civil servants worked hard to provide him with information on which to make a judgement, including suggestions about how the policy could be implemented.
Up until the 1997 budget, pension funds received a tax credit of 20% on dividends received from UK companies. This was to offset corporation tax already paid by companies on their profits. Dividends were assumed to be net of income tax but pension funds (and charities) were exempt so received money back as a tax credit.
Many believed the tax system encouraged institutions with funds receiving tax credits to demand companies pay high dividends rather than reinvest more profits.
Conservative Chancellor Norman Lamont cut the credit from 25% to 20% in 1993. He noted the view that the corporation tax system “…both penalises successful British-owned international companies and distorts investment decisions.”
Will Hutton, author of the influential ‘The State We’re In’, suggested just before the 1997 election that “…If the tax treatment of dividends…was changed [along with other changes]…then the incentives in the system would be redirected towards increasing tomorrow’s profits rather than extracting as much as possible today.”
It was no great surprise when Gordon Brown removed the tax credit, stating that “…it cannot be the best way of encouraging investment for the long term…” Share prices actually rose 0.45% on the day of the announcement, implying that markets expected the move.
Officials had assumed the stock market would fall by just over 7% after the budget, and actuarial valuations of pension funds would fall by £67bn. In most years the tax change cost to pension funds would be £4bn or below until 2007/8 when it would fall.
Many employers had stopped making pension contributions (taking ‘pension holidays’, boosting profits) because actuaries calculated funds did not need the money. Officials noted many funds were in surplus, estimated as £60bn in total. This was predicted to offset some of the tax change impact, although some schemes were affected more than others. Extra employer contributions would be limited and a linked 2% cut in Corporation Tax would help. The Treasury judgement in May 1997 was that, with risks, “…the likely outcome is that pension schemes should be able to cope with the change.”
By 1997, the UK had a poor economic record, with a reputation for high inflation, unemployment, interest rates, and government budget deficits. Steps had to be taken to get the public finances in order and promote a more investment-friendly environment. Abolishing the dividend tax credit and cutting Corporation Tax was one method.
Much has happened since. Shares rose almost 50% to a high in 1999, after which they fell, wiping around £250bn from the market value of occupational pension schemes between 1999 and 2002. Suddenly the risks attached to equities were fully appreciated. Pension funds were hit and some companies that had taken pension holidays could not increase contributions to make up the shortfall, as they were no longer making enough money. Pension liabilities rose as interest rates fell and new calculations assumed life expectancy increased, implying pensions were needed for longer. Pension funds began reducing investment in shares.
Labour responded with a powerful Pensions Regulator and prospective pension reform, along the lines of the Turner Commission on Pensions. No one, not even the Tories, is calling for the return of the dividend tax credit.
The wider lesson from the storm on this issue is that Conservatives and some commentators are projecting a negative narrative about Gordon Brown. It suggests Brown’s instinct is to tax and spend, to be against the City and business, and to be less than frank about it. Unfortunately, some Labour politicians seem to be reinforcing this view.
There is another narrative. It is that the economy is in fine shape and growing steadily. The public finances are in general good order and unemployment, government debt, inflation, and interest rates are low. The Chancellor has channelled billions towards the poor and disadvantaged, and to education and health while promoting business and the City. It is a pretty good record, both in terms of the numbers and the priorities. We should think twice before ignoring it for right-wing political agendas.
|This article previously appeared in Tribune magazine.
Stephen Beer, Friday 13 April 2007.
Central banks are struggling to head off general inflation while dealing with price shocks that will be negative for growth. They waited too long, which has made their tasks more difficult.