Windfall tax a necessary evil to pay for jobs

'The Tories have run into the problem that they introduced a retrospect ive levy on the profits of the high street banks under Mrs Thatcher. What was sauce for the Tory goose in 1981 is now sauce for the Labour gander'

In 1992, when Gordon Brown first suggested the idea of a windfall tax on the profits of the privatised utilities, to pay for special measures to eradicate long-term unemployment for young people, the Labour Party seemed so far removed from the levers of power that scarcely anyone paid much attention. Five years later, while there arestill doubts about whether the levy represents a "good" piece of tax policy - and indeed while some people complain that the "expropriation" of private property should not be tolerated in a free society - the shadow chancellor's political antennae so far seem to have served him well.

For, while almost everything else in the party's programme has undergone profound change, the windfall levy remains, the one distinctive landmark in an otherwise cautious Labour manifesto. If there is one thing in the programme that will get traditional Labour voters into the polling booths on 1 May, this is it. It is surprising that Labour has not yet found ways of making its proposals on youth unemployment a central and positive feature of its campaign, though there is still time.

Perhaps there is a concern that even at this late stage, the Conservatives might succeed in frightening the electorate about the impact of the windfall levy itself. But that looks difficult. It is interesting that the existence of the levy has not scuppered Labour's determination to be seen as the new party of British business. In both business and the City, there seems to be a reluctant acceptance that the profits made by many utilities after privatisation were hard to justify, and came partly at the public expense. These high returns demonstrated either that the assets had been under- priced at the time of privatisation, or that regulation had been too lax since then, or both. Furthermore, it is recognised that many managers in these companies became very rich, not through entrepreneurial flair, but through sitting in the right place at the right time.

This, no doubt, is why the levy is the closest thing to a popular tax that has ever been invented. The Government has never been able to persuade the public that this tax is the work of "unprincipled scoundrels", Ken Clarke's endearingly old-fashioned description of the Labour leadership. In fact, every time the Government has sought to exploit the levy as a political issue, it has simply raised the visibility of what the electorate believes is a darned good idea.

Furthermore, the Conservatives have run into the problem that they themselves introduced a retrospective windfall levy on the profits of the high street banks under Mrs Thatcher. What was sauce for the Tory goose in 1981 is now sauce for the Labour gander. In fact, there was enough support for the levy on the Tory side for Mr Clarke to have considered introducing a similar measure of his own in the Budget of 1995.

Some officials in the Treasury reckon that he was seriously tempted before finally rejecting the notion, on the grounds that it was just too far distant from the Government's overall economic philosophy to be politically feasible. Despite its electoral advantages for Labour, the Institute for Fiscal Studies argues that the levy offends against some of the principles of good taxation. The main problem is that the levy will not necessarily hit the same shareholders who received the excess profits in the first place. In the first few days of trading in the shares of the privatised companies, about a quarter of the shares typically changed hands; and of the original 12 RECs, only Southern Electric has not experienced a total change of ownership since flotation. So there is no doubt that some of the main original gainers from privatisation will escape from the tax scot-free, though Labour points out that most large institutional shareholders have stuck around, and will now pay the tax.

Mr Brown has still not clarified the size, or the exact basis, of the levy. According to a study released last week by Goldman Sachs, a levy of around pounds 5bn has been discounted by the stock market, which is around pounds 2bn more than Labour has promised to spend on its job creation programmes. The pounds 5bn payment might be spread over two or more financial years, but the tax would be unequivocally defined to be a one-off. Any other course would run the risk of increasing the cost of capital for the utilities, which in turn could feed into higher prices at the next regulatory review. Obviously, if the burden of the tax were felt by the consumers of electricity and water, rather than by the shareholders, it would soon lose its political acceptability.

There are many options for the basis for the tax. The only important restriction is that the base should not be subject to the charge that it discriminates between individual companies, or sectors, on arbitrary grounds. Such discrimination would leave the tax liable to challenge in the courts, either in the UK or Europe. But assuming the tax is based on a uniform percentage of some clearly defined aggregate - like profits, sales, assets, or excess returns to shareholders - and as long as it applies to all the regulated privatised utilities, there seems little prospect of it running into serious legal trouble.

The most likely base is the excess return enjoyed by shareholders, over and above the average for the entire stock market, in some specified past period. One advantage of this approach is that it would come fairly close to matching the rationale for the tax. Another advantage would be that a Labour chancellor could in effect choose exactly the companies he wanted to hit, by selecting an appropriate period over which to calculate the excess shareholder return.

For example, if Mr Brown wishes to include gas and telecom in the net of the tax, he would select a period such as the first four years after privatisation, when all companies earned high excess returns.

If, on the other hand, he wishes to exclude gas and telecom, he would select a much longer period - such as from the date of privatisation to the end of 1995. Since gas and telecom earned sub-par returns over the second half of that period, they would incur no tax, though they would in theory be included in the tax net.

The point is that varying the basis for the tax gives a convenient and legal way of discriminating between companies. If a Labour government wished to raise more than pounds 5bn from the tax, that would suggest a need to include gas and telecom, and would dictate the former basis for the levy; while if it only wishes to raise pounds 3bn, the second basis would be appropriate.

Few economists would argue that a tax of this type is desirable in and of itself. Indeed, what tax would be? But if we accept that something needs to be done about the evil of hard-core youth unemployment the money has to be raised somewhere. If anyone has any better ideas, they had better speak up before the employment measures are launched in July.

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