Utilities tax seen as `tip of iceberg'

Labour's plans to raise up to pounds 10bn from a one-off windfall tax on the privatised utilities is only "the tip of the iceberg" and could be levied on an annual basis, a leading institutional investor warns today in a downbeat analysis of the sector.

And an even bigger threat to the utilities comes from the prospect of tighter regulation and increased competition, regardless of the outcome of the general election, leading to "severe downward pressure" on the share prices of the utilities.

"Labour is likely to inherit a high public sector borrowing requirement [PSBR] if it forms the next government, with pressure to reduce it to meet the convergence criteria for European monetary union [EMU]," argues the report's author, Julian Fosh, investment director with Scottish Amicable Investment Managers.

"It is difficult to see how this, or any possible recipient for the cash raised by a windfall tax, could effectively be addressed by a single levy."

Instead, a one-off tax raising up to pounds 10bn, divided into a pounds 2.5bn levy over four years, would provide Labour with a steady income stream. "From there it is only a short step to make it an annual levy," Mr Fosh continues, noting that the targets for the one-off tax - training, education, and youth unemployment - are by their very nature medium- or long-term commitments.

"The motive for making a one-off tax an annual levy is, therefore, strong," he concludes.

Mr Fosh also claims that the impact of an ongoing tax on utilities has been underestimated by investors. "With strong balance sheets, utilities could relatively easily withstand a one-off tax, raising up to pounds 5bn. By contrast, an ongoing tax, even if a lesser sum were raised each year, would reduce future revenues at a time when these are already threatened by limited growth prospects and tighter regulation."

But it is the introduction of full competition that will hit the utilities hardest. "The effects of competition may be sudden and dramatic," Mr Fosh warns. "In gas and electricity, for example, there could be a significant and damaging overnight drop in margins as the regulator hands power to the market."

The regulatory outlook was clouded last week when Professor Stephen Littlechild, the electricity regulator, signalled he might be prepared to loosen price controls on power companies if they were hit by Labour's windfall tax. Labour has consistently denied the tax would have any effect on consumers' bills.