Monday, January 23, 2012

No child benefit for higher rate taxpayers - A political car crash in slow motion

Its been a while since the Conservatives announced that families where one parent is a higher rate taxpayer would loose child benefit payments. Since then, despite some signs from David Cameron that the Conservatives were about to row back on the policy, the chancellor and others have indicated it is still the government's intention to stop families with a higher tax paying parent from claiming child benefit.

Watching this unfold is like watching a political car crash in slow motion. There has been every opportunity to turn off the road, and no shortage of warning signs of the trouble ahead, but the politicians journey continues apace towards a catastrophic collision with the brick wall representing the reality of a policy rapidly approaching its intended introduction date that is utterly and inexcusably dreadful.

Its not so much that a Conservative lead government is putting narrow political imperatives to be seen to be kicking high earners above rational policy making - although that is obviously a problem, it is that the policy is so deeply, obviously and in fundamental respects flawed. To be more specific, the policy makes the child benefit claims of one party dependent on the tax status of another, relies on an eligibility test for benefit that can only be carried out some time after the benefit needs to be claimed, has a horribly complex effect on marginal tax rates (including marginal rates in some instances over 100%), and is desperately unfair on families with only one wage earner.

To illustrate the problems better, here is some extracts from an email I wrote to an MP in the Chancellor's treasury team.

"what has been touted as an administratively simple way to generate £1bn in revenue looks actually to be deeply flawed. I'm not particularly interested in a response - certainly not of the political justification type - just hope you can look into the issues raised below and try to avoid a nightmare.

I think there are three intrinsic features of the proposed scheme that will cause problems:

1) The plan will introduce a discontinuity in effective marginal tax rate, including a marginal rate of more than 100% around the threshold.

The size of the impact, potentially £2k or more on post-tax income will make tax planning essential for those near the threshold. At the margins, tax could completely drive economic decisions, such as whether or not to seek a promotion, or to work harder, and act as a strong disincentive to economic activity, which can't be a good thing.

There will need to be many complex anti-avoidance rules around artificially reducing income for those just above the threshold or in the first year of the change, and opportunities for professional advisors to have a field day, at a time when the tax system is crying out for simplification.

The last time something with an effect on marginal tax rates as crazy as this was tried was Labour's anti-avoidance rules around restrictions on pension tax relief for high earners. The system was ludicrously complicated, understood by very few taxpayers, slated as a complete dogs breakfast (e.g., and rapidly reviewed. The child benefit proposals probably affect a much larger group, who are much less able to deal with the financial consequences than those in the £130k+ income bracket.

2) The tax charge on one person could depend on the child benefit claims of another.
This makes anti-evasion and anti-avoidance measures extraordinarily difficult to frame and enforce. Some habitual benefit claimants are already adept at disguising from the authorities when they are in a relationship or living with someone who actually earns some money if it affects their benefit. I thought the party was trying to move away from this type of nonsense, not introducing the regime to an entirely new part of the population.

For example:
One assumes where parents live apart/are no longer in a relationship - the higher earner cannot possibly have to repay child benefit, as they won't necessarily even know if it is being claimed.

This will leave a whole range of opportunities for some people to avoid the charge. If parents separate during the year - will subsequent child benefit claims be clawed back? How will the authorities determine who is in a relationship (if they aren't married)? What if a family lives together, but owns two homes - with one parent registered at each - how does the government intend to police when repayment of child benefit is required in this instance, or will it just be an honesty box?

Why is the party increasing the 'couple penalty', rather than reducing it?

3) The test for the trigger can only be performed at the end of the tax year, at which point tax is assessed on the benefit claims during the period, so it will be unclear what the tax effect of an action might be until some time afterwards.
This increases the burden of tax planning, and could result in some nasty cashflow problems around tax return time for people with already stretched financial resources. There are two problems scenarios, failing to claim child benefit then suddenly losing income, and claiming child benefit and unexpectedly hitting the threshold. How would you respond to the following scenarios created by these plans in a surgery situation:

- I thought I was going to be under the limit, but I forgot about the dividends on a few shares I own. If I had of remembered, I would have asked my employer to pay me less in March(!!!), but that £500 now means the taxman wants to reclaim £2,000 from me for the child benefit claimed by my wife, and I can't find that type of cash - I'm the only earner, my wife stays at home looking after the children.

- My husband was earning £50k a year, but he lost his job just before Christmas. The Chancellor said it was sensible for me not to claim child benefit, so I didn't, even though there will no longer be a higher rate taxpayer this year. Now we are in real hardship, and they won't let me backdate a claim for child benefit.

This makes a nonsense of the Chancellor's claim that higher rate taxpayers shouldn't claim child benefit. At the very least they would be advised to claim the benefit and put it in the bank.

The points above are mostly applicable to people near the margins, but looking at the policy politically, there will be a major hit on all higher tax rate families. Working people, particularly in London and the South East have been absolutely hammered under Labour - they pay higher marginal tax rates, higher stamp duty, and I think the reason why we have a Conservative prime minister is that in constituencies across the south voters like this were fed up with a bloated and ever increasing state, squandering taxpayers money and mortgaging their children with its borrowing, leaving them picking up a grossly disproportionate share of the bill. If you wanted to devise a magic bullet carefully targetted to do maximum damage to Conservative core support, I don't think you could do much better than attacking families with one parent working on the high tax threshold, the other staying at home looking after children."

The email was acknowledged with a response indicating that the points would be considered. But that was in 2010 shortly after the policy was first announced, and still the car moves on towards the brick wall.

As someone who was a public face for the Conservatives in Cambridge, I know several people who have raised concerns about the effect of this proposed policy with me - in an 'apoplectic with rage' kind of way. The response if the policy is actually implemented doesn't bear thinking about for the government.

Monday, January 9, 2012

Executive pay is out of control

Executives of large companies are a classic example of the agency problem. They are in place to serve the owners of the company, i.e. the shareholders, but it is all too easy for the directors of large companies to put their own interests first, and line their own pockets with remuneration packages that frequently bear little relation to their performance or what a genuine free market would offer them if shareholders had their say.

Its certainly true that the difference between a good manager and and bad manager can make a significant difference in terms of absolute value to a large multinational company. Trouble is, the senior management team are only one part of the equation, and paying a sizable part of the income of a company that may have a vast income generating asset base seems to be no guarantee that you will get management that is even adequate, let alone high performing.

Over the last few years, executive pay seems to have risen out of control. Managers are paid for high performance, and paid off handsomely when they fail. This has come about as the selection and remuneration of senior management has become ever more the decision of other senior managers, and less and less something that shareholders have any serious say over. Remuneration committees benchmark pay according to whatever other companies are paying and then a little bit more to recognise just how special the new managers that the same people have just appointed are, which can provide a self perpetuating cycle of higher pay. As many councillors have discovered, having an 'independent' panel review pay, where that panel is not actually paying the price itself, can often also have an upwards only impact on reward.

Both the Prime Minister and Labour want to see something done about this. I dare say most of the motivation for this sudden interest is political expediency. The gap between rich and poor, and a few managers on extraordinary salaries whilst western economies are floundering are not unimportant - but we never hear similar concerns raised about the income of Premiership footballers or lottery winners. Ultimately Executive pay is mostly the concern of shareholders - but that still means it is the concern of large numbers of people, for example most people with private pension savings. For a a number of reasons shareholders do not currently have a proper voice in setting Executive pay, and government action is now long overdue.

Labour as ever miss the point, in calling for extra transparency. Annual reports for listed companies have no shortage of detail on executive pay, it doesn't need more taxpayers cash being squandered tabulating this information.

It remains to be seen what the Government has in mind in terms of empowering shareholders, but the first step to a proper solution is to understand the problem. Large plcs usually have a very diverse shareholder base - so it is hard for a group of shareholders to get enough support to block excessive pay. Many individual shareholdings are now held in nominee accounts - where by default shareholders are often denied invitations to vote on executive pay and attend AGMs. The situation is worse for investors in unit trusts or pensions, where decisions are taken on behalf of investors by scheme managers - who may be rather closer to the executives of companies, than they are to their investors.

So I have a suggestion for government for how to tackle executive pay excesses. With the ready availability of online account servicing from most providers, it should be made compulsory for the 'beneficial owner' of every shareholding in listed companies to be given the opportunity to vote electronically on all company resolutions via the fund or nominee account manager. It should then be compulsory for senior executive remuneration to be subject to approval by these beneficial owners, and it should be possible for small groups of shareholders (say any group with the support of 5% of the shareholders) to propose alternative remuneration schemes.

This would not just apply to shares held in nominee accounts, but also to shares held in pension funds and shares held in unit based investment funds. The fund managers should be required to make the beneficial owners aware of all the companies that their funds are or may be invested in, and give them the opportunity to indicate how they would like to vote on any resolutions, which should be binding on the fund manager for the part of any shareholding attributable to the beneficial owner. This would do away with cosy block votes for fund managers, and herald a new age of shareholder activism.

It might be that shareholders continue to support large executive pay packages that seem to pay out regardless of the long term fortunes of the company - its would be their choice, and it may be in their interests to do so. But more likely I think it would result in executive pay being reigned in, and more importantly, becoming much more aligned to long term shareholder interests.