Jeremy Warner's Outlook: Gesture politics backfires on Chancellor

As on so much else, the Chancellor has got himself into a terrible mess over the taxation of non-doms (foreigners resident in the UK). There appeared to be a partial climbdown last night – though not over the proposed £30,000-a-year annual levy on non-remitted overseas income – yet the damage has already been done, and, even if the threatened mass exodus of non-doms doesn't materialise, foreign talent is going to be that much less willing to locate here in Britain than it was.

That's the problem with on-the-hoof, gesture, politics. The non-dom policy was a piece of flagrant populism, essentially stolen from the Tories at a time when the Government was considering calling a snap election which it eventually called off.

In its attempt to win votes, Labour has created a deeply damaging international row and possibly irreparably harmed its relations with the City for very likely only a marginal short-term boost to the tax take. The longer term damage both to the City and the tax base could be significant.

Meanwhile, the Chancellor has again been forced to compromise, making him look weak and foolish. He's damned by left and right alike, on one hand for caving in to the rich and influential and on the other for attempting to tinker with the City's favoured tax status in the first place.

The furore over non-doms has highlighted an issue in fiscal policy as old as the hills, which is the extreme difficulty of taxing the super-rich in any meaningful way without having the opposite effect to the one intended and making the public purse poorer, rather than richer.

A few figures neatly illustrate the nature of t he problem. Back in 1978, with still ruinously high marginal rates of tax for those on high incomes, the top 1 per cent of earners paid 11 per cent of the total income-tax take, and the top 10 per cent some 35 per cent.

With much lower rates of tax for high earners, these figures had by 2001/2 dramatically changed. The top 1 per cent of income earners were paying 23 per cent of total income tax, with the top 10 per cent accounting for more than half. These proportions will almost certainly have grown further since then.

Lower rates of tax have led to a virtuous cycle of wealth creation, which in turn has created more top earners and as a consequence a bigger tax take overall. This is not the only reason the tax base has risen, of course, nor obviously is it the case that the lower the rate of tax, the more tax that will be raised.

What is true is that the richer people get, the more of a problem they have with paying tax. Rightly or wrongly, those that pay for their own health care and education privately tend to resent paying all over again for everyone else through the tax system, which in any case they regard as inefficient and wasteful.

For the super-rich, tax has long been a voluntary affair, at least in part. There is some tax they cannot help paying, but plenty they can avoid. Whatever Her Majesty's Revenue and Customs does to close the various loopholes used to avoid tax, clever accountants will always find new ones.

If the tax system becomes too onerous, then the law of diminishing returns kicks in. The rich can live where they like, and will move abroad if the tax environment becomes too harsh. The economy would also become less capable of attracting foreign talent while the wealth creators would become less inclined to work their magic. The ultimate outcome is less tax, not more.

Alistair Darling, the Chancellor, seemed to acknowledge these inconvenient truths in last night's partial climbdown over the taxation of non-doms. Interestingly, the original proposals seemed politically uncontroversial when they were first announced in the pre-Budget report last autumn.

The Lib Dems have been banging on for years about taxing the super-rich including non-doms more heavily, and only a few weeks previously the Tories had stolen the Chancellor's thunder with proposals for something very similar. Alistair Darling must have thought he was on to a winning policy that could command a political consensus.

The Tories propose an annual fee of £25,000 for being taxed on a remittance basis, Labour the rather higher figure of £30,000. Even for the wealthy, £30,000 a year is a substantial sum of money, yet it might also be thought a small price to pay for being tax-free on overseas earnings that are not remitted to the UK. The non-doms, it was widely thought, would simply grin and bear it.

Then about a month ago, legislative proposals were brought forward for the separate taxation of offshore trusts and a change in the rules governing residency for tax purposes. What for many non-doms would have been a minor, but probably tolerable, irritant, overnight became a severe threat to livelihood and wealth.

In an effort to crack down on the use of trusts for hiding UK income offshore, or for remitting foreign earnings to the UK tax-free, the Government seemed to be proposing that any realisation of money from offshore trusts be taxed. That's when the proverbial hit the fan. Few are going to have any sympathy for the already super-rich being made to pay a little more tax, but fairness in the tax system is not the issue at stake here. Rather it was Labour's hard-won reputation for business- and City-friendly public policy.

There is no doubt what super-rich non-doms would have done had they found their worldwide gains taxed as proposed by the UK authorities. They would have left, and the country would undoubtedly have been the poorer for it. In the round, it may be better to have the super-rich living in Britain paying no tax than not here at all. Yet most other developed countries tax residents on their worldwide income, not just on what they earn in their country of residence. Britain is anomalous. Should that have been allowed to continue?

It is a perverse consequence of the present set-up that it is actually much better to be a wealthy foreigner resident in Britain for tax purposes than a a wealthy Brit, many of whom find they have to move abroad to gain the same tax perks. The £30,000 annual fee will only marginally close the gap on this disadvantage.

If there is a lesson to be learned from all this, it is on the dangers of badly thought-out policy produced without consultation for reasons of political expediency. After years of ducking the non-dom issue, the Government was embarrassed by the Tories into making a reform that neither satisfies those who complain about inequity in the tax system nor in the long run is likely to make the public finances any better off. All in all, then, another triumph in public policy.

A banking season to watch out for

The banking season kicks off today with annual results from Bradford & Bingley. The rest are due to follow at some stage in the next three weeks. To judge by the disastrous collapse of banking share prices over the past six months, you'd expect these results to be equally calamitous, with earnings holed below the water line and dividends cut to match.

Yet nobody expects such an outcome. Auditors may have forced a more hard-nosed approach to impairment charges than the one used to date, but underlying profits will continue to look healthy and dividends are expected at least to be maintained and in some cases increased.

The $64,000 question is what's going to happen this year. Will regulators force banks into dividend cuts, capital raising and asset disposals, or are British bankers right to insist, as many of them still do privately, that they can achieve an orderly work out with earnings relatively undamaged and capital rebuilt through organic means? Regrettably, we are unlikely to get much enlightenment. "Poor visibility going forward" is likely to be the defining phrase of the banking season.

j.warner@independent.co.uk

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