Leading Article: A better way to close loopholes

Last week, the Chancellor inadvertently parked his tanks on the lawns of the many workers who hold or would like to hold shares in their companies, when he accepted the Greenbury committee's recommendation to subject share options to income tax rather than capital gains tax. Now he should have the courage to organise an orderly retreat.

The original idea, welcomed as over-hastily by the Independent as by the Treasury, was to prevent highly paid corporate executives from exploiting a tax loophole which treats gains on capital more generously than income. But then battle commenced. An unlikely alliance of Tory MPs and Asda check-out staff formed to explain that thousands of middle managers and shop-floor workers would suffer disproportionately if the loophole were closed. The first general to desert from the Government's ranks was Sir Richard Greenbury. This morning, the committee meets to try to devise a compromise formula and Sir Richard will meet Kenneth Clarke in the afternoon. Since the mechanism for implementing any change is the November Budget, the Chancellor still has time for a rethink.

Mr Clarke was right to spot flaws in the Discretionary Share Option Scheme. Since the aim of subsidising employee share ownership is to deepen the relationship between employees and their companies, this scheme was never likely to help much, since it does not encourage new shareholders to hold on to their stakes. From this point of view, the Save As You Earn Share Option Scheme and Profit Sharing both offer better ways to stimulate long- term employee share ownership. Mr Clarke should seriously consider widening the scope of these schemes.

But scrapping the discretionary scheme overnight and retrospectively is wrong. The tax rules around which people organise their financial commitments should only be changed with adequate notice, other than in the most exceptional cases. Sudden lurches make for unfairness; there are many employees who accepted share options in lieu of extra cash in their wage packets and who will lose out if the law is changed midway through the operation of their schemes.

Worse still, as is so often the case, the Chancellor's dawn raid looks unlikely to have much impact on the board-level people at whom it was aimed, since the tax breaks involved are tiny in the context of large earnings and easily avoidable by anyone with a diverse shareholding portfolio.

What ought Mr Clarke to do? His aim should be to allow firms with schemes already in place to continue them for ordinary employees, while ending them for board members. That would best be done by stipulating an annual value of shares per employee that would be exempt from tax, rather in the way that Tessas and Peps offer a tax-free element. There would then have to be an income cap beyond which this benefit would not be available. An alternative route would be to give a period of transition during which companies could transform discretionary schemes either into Save As You Earn or Profit Sharing plans. In that time, option holders' tax position would be protected.

Encouraging employees to own stakes in their companies is a good thing. It helps in building corporate cultures and fosters a more long-term view of the relationship between businesses and the people who work for them. Mr Clarke must now find a more discriminating way of closing tax loopholes without undermining that goal.