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Clarke may be gunning for profit-related pay

There may be more than meets the eye to Kenneth Clarke's dawn raid on executive share options. The 6am announcement has generally been interpreted as either a spiking of Gordon Brown's guns on an issue that has caused the Government grief, or as a miscalculation of the backlash from the "little people" caught up in the Revenue's dragnet.

What seemed clear was that the potential gain to the Government's finances was neither here nor there: pounds 70m is small change to a government spending pounds 300bn a year.

Yet while the tax relief on executive share options may be small beer, the cost of another employee tax break, on profit-related pay (PRP), is currently pounds 800m, up from pounds 550m last year, and equivalent to over a quarter of tax relief on mortgage interest. If it carries on growing at the current rate, this jack-in-the-beanstalk tax exemption will be looking down from a great height on mortgage tax relief before the 1990s are out.

Four years after it was first introduced in Nigel Lawson's 1987 Budget, there were only 350,000 employees in profit-related schemes. Lord Lawson says in his memoirs: "The cost would not be large even if the scheme were a runaway success." However, in his 1991 Budget, Norman Lamont doubled the relief, which now stands at pounds 4,000 or 20 per cent of pay, whichever is the lower. In the four years since then the number of employees in PRP schemes has burgeoned to 2.4 million. This shows the speed with which tax reliefs can get out of hand.

The purpose of the tax break was to get profit-related pay off the ground. The idea was that if pay could be made to vary more in line with companies' fortunes, employers would be less trigger-happy in sacking their staff in bad times.

But according to recent research conducted for the Treasury and the Inland Revenue, employers who have introduced PRP do not believe it has had any substantial effect on making pay more flexible. The report was in no doubt that the tax relief for PRP had stimulated significant take-up of schemes. But it acknowledged that one of its main benefits was tax efficiency, which equates to a tax loss for the Inland Revenue. The Treasury is known to be worried about the burgeoning cost of this particular tax relief - as well it might be.

Against that background, Kenneth Clarke's pre-emptive strike on executive share options starts to make more sense. With the Chancellor's hands tightly tied by public spending pressures in a pre-election year and tax revenue coming in lower than initial projections, he will need more than the usual smoke and mirrors if he is to provide the income tax cuts backbenchers are baying for.

One way to square the circle is to cut tax reliefs like the one on PRP. Find one or two more like these and the Chancellor will be well on his way to 2p off the basic rate - and all without frightening the children in the City. We may well have seen in Mr Clarke's dawn raid a first stab at the Budget strategy that was discussed over the weekend at Chevening. No wonder the Treasury grabbed so enthusiastically at the recommendation for abolition in the Greenbury report.

Electricity mergers unlikely to be hindered

With two down and as many as five more likely to go, the reorganisation of the 12 regional electricity companies is gathering pace. Manweb and Sweb are under offer, Northern is expecting a new bid from Trafalgar any day now, South Wales Electricity is on most analysts' lists of bid candidates, while Yorkshire has been kept under a spotlight by SBC Warburg's continued ownership of a sizeable stake, which was 5 per cent at the latest count and would make an excellent platform for someone else to bid.

Add in the clear ambition of Southern, one of the strongest recs, to bid for or merge with another regional company, and you have six or seven of the 12 likely to be caught up in the rationalisation of the industry over the next year or two. In fact, the limit is not the number of targets but the length of the list of known predators, which is currently rather short even if Hanson is included.

Manweb was near the top of most lists of targets. It is the rec that sticks closest to its knitting, making the bulk of its profits from distributing electricity to customers and showing little inclination to diversify abroad or into other related areas such as power generation. This is a perfectly acceptable policy as long as it produces above-average rewards. But Manweb has rather undermined its defences by dropping a few stitches from its knitting along the way.

It is perceived as one of the weakest of the recs, it was hit hardest by Professor Stephen Littlechild's pricing review, and it has even managed to sell five retailing superstores to Scottish Power, which is embarrassingly able to prove it can do something with Manweb cast-offs.

With job losses a certainty at Manweb if Scottish Power's bid goes through, the campaign for a monopolies reference is under way. Professor Littlechild and the Office of Fair Trading might be looking for an excuse to kick one of the growing number of bids for recs into touch so the MMC can look at the issues.

This is certainly the first bid by one electricity company for another and also the first to result, if successful, in vertical integration between power producers and suppliers. But even if they did want to open up the entrails of the electricity industry for inspection, it is hard to see how the OFT could justify an investigation of a bid by a well managed company for a weaker one with which it has very little overlap on supply or distribution.

More important, the Government does not see any serious problems in a consolidation of the industry. Supposedly, the domestic electricity market is to be opened up to competition from 1998, allowing new suppliers to send their power down the distribution networks to consumers. Parallel changes are to start next year in the gas industry, where British Gas will face competition in the domestic market for the first time.

Nobody believes the electricity industry is ready for this brave and difficult new world, as the Commons select committee on trade and industry will reaffirm in a report today. There has been enough trouble already with the liberalisation of commercial and industrial supply last year.

With serious questions over whether new billing and metering systems will be ready by 1998 for 23 million private consumers, deregulation may have to be delayed until after the consolidation of the industry into bigger units that can cope with the management and technical challenges. The Government therefore has a clear interest in encouraging mergers and would not be concerned by a power industry controlled by half a dozen big groups.

Coincidentally, the Government replied yesterday to the committee's report on the wider issue of UK competition policy. While dismissing the committee's well argued case for reform, the reply did say that companies with strong market share posed no particular competition problem as long as there was easy entry for domestic and overseas competitors. In electricity, with generators moving into distribution, and Southern thinking of teaming up with its near namesake in the US to bid for UK power stations, there should be few official obstacles to electricity mergers.

Edited by Peter Rodgers