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Thursday, April 12, 2007

Revisiting those dividend tax credits

The dividend tax credit storm of last week was an interesting bit of politics. Essentially, there is a narrative about Gordon Brown being promoted by some on the right and we saw that again with this story. Perhaps the disappointment was that Labour went on the defensive and conceded ground on our economic record.

What was the issue?

The Times secured the release of Treasury advice to the Chancellor in 1997 as he was planning to remove the tax credit on dividends.

Until the '97 budget, pension funds received a tax credit of 20% on dividends from UK companies. The original rationale was that companies paid dividends from profits that had already been taxed. It was therefore assumed income tax had been paid on dividends received. Basic rate taxpayers did not have to pay additional tax. Pension funds (and charities) were exempt from income tax and therefore received money back.

Many thought this system favoured dividends (for tax reasons) instead of investment (companies could have invested more if they paid lower dividends). This was seen as a reason for a poor UK investment record.

Chancellor Norman Lamont in 1993 acknowledged the view that the tax system "...both penalises successful British-owned international companies and distorts investment decisions."

Will Hutton, writing in 'The State We're In' stated that the tax credit was partly responsible for " acute demand for dividends and the foreshortening of investment time-horizons," and later suggested (in 'The State to Come') that "...If the tax treatment of dividends...was changed [with other changes]...then the incentives in the system would be redirected towards increasing tomorrow's profits rather than extracting as much as possible today."

So it was not really a surprise when Gordon Brown announced such a measure in his budget in 1997 (indeed, the market didn't seem that bothered on the day).

So, what was the nature of the advice and how should we view it now? That will be the subject of my next post.

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