City & Business: There's no such thing as victimless tax

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The Independent Online
There is a growing nervousness in the City that a new New Labour government will make yet another assault on the tax privileges of pension funds.

Under the Tories tax-exempt funds have already seen the erosion of the level of the dividend tax credit from 25 per cent to 20 per cent. Now there is a real fear that a Labour government will take the erosion to its natural conclusion of phased abolition of the tax credit.

Naturally, on an issue of such sensitivity, the Labour Party denies it has any proposals to remove the tax credit. However, with around pounds 6bn of easy tax revenue at stake it would not take long for such proposals to be drafted once in power.

Tax credits are a tempting target for a chancellor who is committed to prudent financial management of the economy but has his hands tied when it comes to increasing the income tax burden.

To start with, institutional investors are relatively faceless non-voters which could easily be seen as appropriate targets for Gordon Brown's Robin Hood approach to taxation. More importantly, tax credits are extremely complex both in terms of their practical application and any interpretation of their removal.

The best tax is one which no one understands. Offered the opportunity, then, to raise pounds 6bn with very little political flak it might be seen as rude to refuse.

By phasing the abolition over three years the new chancellor would be able to mitigate the impact of the removal of the tax credit on the stock market. Reduction of the credit to 15 per cent suggests a 3 per cent fall in the FT-SE 100 Index. Complete abolition would mean the index had to fall by nearer to 10 per cent in order to adjust the market's yield to account for the reduced income from dividends.

A possible hidden attraction of such a move is that the removal of the tax credit would be particularly bad news for PEP schemes which are big beneficiaries of the tax credit. There has been speculation about whether Labour would protect these popular tax shelters. The effect of removing the tax credit on dividends would be to reduce the attractions of PEPs without actually abolishing them. In other words, PEPs would be retained but no one would want to invest in them. Neat.

However, while there is a compelling symmetry to this fund-raising it is not without its dangers. There will be a temptation, fuelled perhaps by the lack of opposition to the windfall tax on utilities, for a Labour government to resort to the corporate sector to boost tax revenues.

Unfortunately there is no such thing as a victimless tax. Be it removal of tax credit, windfall tax or increased corporate tax rate, somebody has to pay. There is a big difference between being a prudent economic manager and merely a creative tax raiser.

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