Dorrell fails to calm City fears over dividends: Warning that higher taxes on pension fund returns would undermine market

CITY criticism of Stephen Dorrell, Financial Secretary to the Treasury, is growing despite his attempt at the weekend to soothe fears about the introduction of a less favourable tax regime for dividends in the next Budget.

Mark Wasilewski, director of UK equities at NatWest Investment Management, said: 'If the Government increased taxes on returns received by investors, it would undermine the market. It seems politically driven.'

Mr Dorrell said there had been an over-reaction to his suggestion that companies had been paying excessive dividends, and he was astonished at the unease his remarks had caused. He was looking at reforming tax structures in a way that would have a neutral effect on government revenues.

Yet Mr Dorrell refused to rule out a cut in tax relief on pension funds' dividend income.

Gerald Holtham, chief economist at Lehman Brothers in London, said: 'A move to make the payment of dividends less attractive would reduce the attraction of equities to institutions, although how much share prices fell would depend on the precise change.'

Sushil Wadwhani, equity strategist at Goldman Sachs, has estimated that abolishing the 20 per cent tax credit on dividends could take nearly 15 per cent off share prices. The estimate is based on Norman Lamont's reduction in pension funds' tax credit from 25 to 20 per cent in the March 1993 Budget, a measure that saved the Exchequer pounds 1bn a year.

Mr Wadwhani said: 'Mr Dorrell has softened his tone, saying he is not seeking to raise extra revenue. If the Government were to, say, abolish the tax credit but also cut corporation tax, it would still hit equities but by perhaps only a third as much.'

The apparent consensus between parts of the Government and the Labour Party on the need for tax reform has nevertheless strengthened City fears.

Kenneth Clarke, the Chancellor, said recently the Government was 'very actively looking' at what it could do to discourage high dividend payments. Robin Cook, Labour's Trade and Industry spokesman, also said dividends were too high.

The ratio of dividends to earnings rose above 60 per cent in 1992, although provisional figures suggest it fell below 50 per cent last year.

'Dividend cover has been as low during previous recessions,' Mr Wasilewski said. 'With a very few exceptions, institutions are wary of over-distribution, and they bring it to the attention of companies.'