It’s hard to underestimate the anger in the City over Alistair Darling’s decision to introduce a flat 18% rate of capital gains tax. I’ve been bombarded with emails from fuming entrepreneurs and shareholders. For the Chancellor to have united all four leading business groups plus the unions in opposition to his bungled reform shows staggering ineptitude. It’s hard to see how Darling can win back the confidence of business.
The irony is that what Darling was trying to do was broadly sensible. Britain’s bloated tax code and soaring cost of compliance has been a major gripe of the business community. It has long been obvious that the answer is simpler, flatter, fairer taxes. Capital gains tax, with its different rates for different assets and fiddly allowances, was a classic example of Gordon Brown’s fetish for tinkering with the tax system – and the result has been big distortions in economic behaviour. Why should the tax system favour private equity, which is eligible for taper relief, over the stockmarket, which is not, for example?
But Darling made two big mistakes. The first was not to make any allowance for inflation. That is unfair on people who have held assets for a long time, such as small business owners. Under the current regime, assets acquired before 1982 are indexed to 1998 prices and then eligible for taper relief on any gains above that amount. So if a shopkeeper bought his business for £1m in 1982 and planned to sell next year for £4m, the purchase price after indexation would be £2m and the total tax bill at the current 10% CGT rate would be £200,000. But under the new regime the shopkeeper would have to pay 18% tax on the full £3m gain, more than doubling his tax bill to £540,000. Darling has taken a system that encouraged people to invest long-term and made it one that penalises them.
Darling’s other big mistake was to use simplification as an excuse to gouge another £900m a year out of business. That has completely undermined his claim to the high ground. Had he foregone the temptation for a tax grab and ploughed any extra revenue raised into a lower rate, he might have won the benefit of the doubt. Instead, he played to the gallery, wrongly suggesting the bulk of the extra tax revenue raised would come from private equity, rather than entrepreneurs. In fact, private equity was secretly delighted with the result. It had been terrified the Chancellor would get rid of its cosy deal with the Treasury allowing it to treat carried interest – effectively performance fees – as capital rather than income. This didn’t happen.
Naturally, the Tories have been quick to seize on Darling’s mistakes, throwing their weight behind opponents of the new flat tax. But in their new role as potential government-in-waiting, they need to think carefully what they would propose instead. The losers from Darling’s move are vocal and well organised, but there are plenty of winners whose voices are not being heard, including second home owners and public company shareholders. Besides, it was the Tories own Tax Reform Commission that first proposed abolishing a flat rate of CGT, albeit retaining a taper that ultimately cut the rate to zero after ten years. An alternative approach would be to reintroduce indexation on all assets. But retaining the current complex system with its perverse incentives is not a clever move largely because it would undermine the laudable goal of flatter, fairer taxes.
Sovereign wealth funds
A lot of people are getting hot under the collar about sovereign wealth funds – the giant state-sponsored funds which typically invest the proceeds from natural resources such as oil and minerals. But much of this debate is at best hot air, and at worst, a thin cover for protectionism. These funds have been around for years. The Abu Dhabi Investment Authority and Temasek, the Singaporean sovereign fund have been big players for years. What’s changed is that the amount of money these funds control has started to grow very fast. Between them, they currently control $2,200bn, according to Standard Chartered and on present trends could reach $13bn in 10 years. They’ve also started to buy bigger stakes in companies and sometimes entire companies.
Inevitably, this has provoked calls for restrictions on their activities. This is dangerous territory. Yes, where necessary, any strategic issues raised by foreign state ownership of businesses should be tackled. But it’s hard to think of many industries where these concerns apply (defence, energy, the media, perhaps) and, more importantly, there is not much evidence these are the true targets of sovereign funds. The bulk of money used to take big stakes in foreign companies has actually been directed at the financial sector, according to Morgan Stanley. These include China’s stake in private-equity group Blackstone. The trick for investors is to spot the next target. Morgan Stanley suggests firms with a strong emerging-market focus. Rather than worry about sovereign funds, the smart thing to do is buy shares in companies such as Ashmore (ASHM), Bluebay (BBAY) and Julius Baer (BAER).