Rt Hon Lord Lilley

    Mr. Peter Lilley (Hitchin and Harpenden) I beg to move amendment No. 16, in page 109, line 18, column 2, leave out ’25’ and insert ‘nil’.
    The First Deputy Chairman With this, it will be convenient to discuss amendment No. 17, in page 109, line 18, column 4, leave out ’60’ and insert ‘nil’.

    Mr. Lilley The existing system of capital gains tax is horrendously complex, which, above all, is because of the 344 indexing procedures, which protect investors from the consequences of inflation. The tax can also freeze capital that has been held long term and has made a large gain, which people are reluctant to realise. There was considerable attraction in scrapping indexation and replacing it with tapered taxes. I have floated such a scheme, subject to certain conditions, and the Confederation of British Industry and the Institute of Directors expressed interest in principle in the idea.
    The Government’s proposals, however, are running into increasing flak now that they have been published in the Bill. Hon. Members will receive representations from several sources attacking those proposals for a variety of reasons. Why has that happened? I believe that it is because the wrong sort of consultation was carried out on reform of capital gains tax. The Government asked for ideas, but people were not given a specific proposal to focus on or to get their teeth into.

    I received a letter from a constituent who is a distinguished accountant, who writes:

    The capital gains tax changes show the difficulty of moving directly from a very wide-ranging consultation exercise, for which the Government set no parameters, to an announcement of legislation with immediate effect. It is extraordinary that the Government kept their basic proposals secret throughout the consultation and sprang them on us fully fledged—deus ex machina—in the Bill. We cannot give them the sort of consideration that a proper consultation would have allowed.

    The proposals are a dog’s breakfast, partly because the Paymaster General has, as usual, played a major part in preparing tax reform, which is his responsibility. He is not familiar with capital gains tax because most of his holdings, such as TransTec and so on, are in the Channel Islands and escape it. He can be excused; his vast business experience has given him first-hand experience of other taxes, but not of that one, so he is perhaps the wrong person to hold such responsibility.

    A few weeks before the Budget, I tentatively suggested that a tapered system might be considered and that the key condition must be that the tax rate on assets held for a period, up to 10 years, for example, should come down to zero. Without that, capital gains tax would become a tax on inflation and on the rise in the value of assets, which merely reflected the deterioration in the value of money—in effect, a wealth tax.

    That is what the Government put forward. Their proposal means that a person who held assets for 10 years would be liable to pay tax on 60 per cent. of the gain, even if inflation remained at the target rate of 2.5 per cent. He would pay about 0.6 per cent. per annum of his wealth to the Government in wealth tax. The proposal is of similar magnitude to the previous Labour Government’s wealth tax proposals, which the hon. Member for Dudley, North (Mr. Cranston) is about to defend.

    Mr. Ross Cranston (Dudley, North) When the right hon. Gentleman floated his idea, the press reported that City institutions were taken aback by the fact that he had reversed his previous stance. The press also expressed surprise about where he was going on capital gains tax generally, because he also floated the idea of abolishing capital gains tax. Will he tell us his policy on that?

    Mr. Lilley I saw no such reports. Many people welcomed my proposal, particularly at the prestigious 345 financial gathering to which I addressed it. Some leading firms of accountants also welcomed it. They welcome it all the more, now that they have seen the Government’s failure to take into account the conditions that I specified and which the Government ignored.
    Our amendments propose that the tax should come down to a zero rate for long-term gains. That is a reasonable proposition. I believe that several countries have zero rates for long-term gains. Such rates come in considerably earlier than would be the case if the phasing that the Government are proposing were to be implemented. They cannot suggest that this is unfeasible or impractical. Abolition would be a step in the right direction, because the one area where our taxes are if anything more onerous than they are abroad is taxes on capital. We should be moving in the direction of alleviating that burden, not adding to it. I fear that the Government’s proposals will add to the burden of capital gains tax. I shall return to that shortly.

    There is another bizarre consequence of the spectrum of rates that the Government have proposed. The total number of rates of tax that can apply over a 10-year period is measured in the low dozens as a result of the basic and upper rates of tax. For the first time, there are separate rates for business and private assets, and rates will vary from year to year. The consequence is that, over the medium term, the rate of tax that people pay on real gains could work out substantially higher than the current 40 per cent. Even in the longer term, that could happen if inflation is high or money gains are low.

    If inflation remains at only 2.5 per cent. a year, people’s private assets will have to increase by 5.2 per cent. a year for 10 years to have a lower tax rate than 40 per cent. on the real gain being made. If they make less of a money gain than 5.2 per cent. per annum over that period, they will pay a higher rate of capital gains tax than under the present system.

    The system is worse still in the interim. When the assets have been held for only three or four years, people could pay a real rate of tax of 60 per cent. or more. Is that the Government’s intention? Do they want to penalise people who realise gains in the medium term if those gains are comparatively modest? If so, why? I do not know whether the Financial Secretary or the Economic Secretary will reply.

    Dawn Primarolo indicated assent.

    Mr. Lilley I am glad that the hon. Lady is noting down that question, and I look forward to her explanation of why this rather bizarre pattern has been incorporated in the Bill.
    With the changes goes the abolition of retirement relief, which exempts entrepreneurs who have built up their businesses and sell them when they are over 50. That sensible reward for entrepreneurship is being entirely withdrawn. The result will be that people who make a real gain on businesses that they have built up and who otherwise fulfil the conditions for the relief will be worse off under the Government’s proposals if the gain is £500,000 or less.

    However, as the Forum of Private Business points out, 346 at the other end of the spectrum, a business owner who makes a gain of £2 million on selling an enterprise will be £350,000 better off than under the present arrangements. The Forum of Private Business rather tartly comments:

    That is not the sort of redistribution of wealth that one might have expected from a Labour Government. Again, we should like an explanation from the Financial Secretary.

    Did the Government intend, or was it an accident, that their changes to retirement relief should result in a system whereby those who make small or modest gains in their business life have to pay more tax and those who make rather larger gains have to pay less tax? The Institute of Directors points out that it would be perfectly possible to vitiate that effect by changing the present structure of rules on the size of reliefs and the points at which they come in, from £250,000 and £750,000 slices to £100,000 and £300,000. Are the Government deliberately failing to do that, or did they just make another mistake of the sort with which we are becoming familiar?

    There is a special transitional problem. Retirement relief is being phased out over the years 1999 to 2003, but the gain on a business asset cannot fall to 25 per cent. of the full gain until 2007 at the earliest. Therefore, there is a period between 2003 and 2007 in which one relief has gone, but its replacement—such as it is—has not fully arrived. That is an urgent problem for entrepreneurs who have planned to retire in that period. It should be solved by phasing out retirement relief—or preferably phasing it down to a new reduced level—over the period to 2007 and not to 2003.

    That is the suggestion of the Institute of Directors, and I commend it to the Government for their consideration. I look forward to hearing Labour Back Benchers support the perversity of the changes, which clearly hit small business harder than bigger business and which have a redistributive effect that is the exact opposite of that for which we were led to believe Labour—at least, old Labour—stood.

    The 30-day rule clearly was not thought through. It was designed to put an end to bed-and-breakfast transactions, whereby people sell shares and buy them back overnight in order to realise their gains and make use of their personal reliefs. The Government did not think it through and, within hours of the announcement, the City had come up with devices involving futures transactions that enabled those who are sufficiently well off to use such devices to circumvent the rule. Not everybody can do that, so it would be better not to have the rule, in the interest of fairness.

    Not to have the rule would also be in the interest of operational feasibility. One of the principal companies involved in providing financial software—a company called Financial Software Ltd.—has pointed out that it is almost impossible to revise existing programming systems to cope with the new 30-day identification rule. The company states:

    From a technical perspective, the Inland Revenue seems not to have considered the effects of any corporate reorganisation within this new 30-day period identification rule. The implications are that large chargeable gains or allowable losses can be immediately crystallised and these effects are hidden to the extent that investment managers can find themselves caught out by such changes unexpectedly happening in a 30-day period when they are selling and intending to buy back shares.

    347 The Government appear to have created a system that cannot properly operate. My hon. Friend the Member for Sevenoaks (Mr. Fallon), the shadow Financial Secretary, wrote to the Paymaster General about that and other measures, and received a letter in reply that referred to the implications for married couples. The Paymaster General said that the 30-day rule will effectively not bite on married couples; if one of the individuals sells shares and the spouse buys them back within that 30-day period, they will not be caught.

    It is heartening, to some of us who thought that the Labour Government were in the business of removing every recognition of the married state from the tax system, that bed and breakfast will be allowed to continue as long as it is in the marital bed, but it is odd, and we should like clarification from the Government as to whether that is intended and whether it will persist.

    Mr. Tim Loughton (East Worthing and Shoreham) Does my right hon. Friend agree that the ending of bed and breakfast mitigates most harshly against smaller investors, for whom the capital gains tax allowance of £6,800 is all the more important, and that, effectively, if they are locked into a successful investment that they do not want to sell, they will lose their £6,800 CGT allowance? Should not the Government come clean and abolish the allowance altogether if that is what they intend, and appear to be trying to do through the back door?

    Mr. Lilley My hon. Friend is absolutely right about the unfairness and the increasingly apparent, almost characteristically perverse, redistributive effect of Government measures, such as the capital gains tax relief changes and the changes connected with the introduction of ISAs, which penalise smaller investors and smaller savers while relieving larger and top-rate savers. However, I regret the fact that my hon. Friend suggested that the logic of the Government’s position is to eliminate capital gains tax relief entirely, because I fear that, once it is lodged in their head, the Government might find the idea irresistible.
    Taken as a whole, the proposal is a dog’s breakfast. It is a wealth tax by the back door, a tax on inflation and, almost certainly, yet another tax-raising measure. The Red Book shows a loss of some £25 million of revenue followed by an increase of some £25 million of revenue in the subsequent year, but there is no sign in the Red Book, or in the accompanying press release, of the long-term impact on capital gains tax revenues that is expected to result from the change.

    Mr. Cranston Has the right hon. Gentleman made any calculation of the revenue effect of his amendment?
    4.30 pm

    Mr. Lilley One of the conditions that I specified in my original proposals, which effectively contained the amendment, was that there should be an attempt to introduce them in a manner that was revenue-neutral, if possible. I believe that that is possible, because a tapered system will encourage more transactions when the rate 348 reduces to a more reasonable level, so revenues would rise, not fall. That is the sort of Laffer effect that one would anticipate in these circumstances.
    However, we cannot make such calculations if the Government will not give us figures for the long-term consequences of their proposals. How can we calculate the revenue effect of the amendment, when it would amend something the consequences of which the Government have kept secret?

    I want the Minister to tell us the long-term implications of the measure. I am not the only one who believes that it will be a revenue-increasing measure and a further tax burden; most accountants and experts to whom I have spoken arrive at the same conclusion, from their own estimates. However, we would welcome any clarification from the Government as to whether they have made any estimates of the long-term consequences of the changes; if so, we should like to know what they are.

    Later we shall ask the Committee to vote on amendment No. 17, which effectively eliminates the wealth tax effect of the measure, by reducing the long-term capital gains tax rate to zero. I hope that, when the opportunity comes, hon. Members will join us in that vote.

    — Later —

    Mr. Lilley This has been a very good debate, with extremely high-calibre speeches from everyone—not excluding the Minister, who was her characteristically charming and punchy self. She had to respond to an array of talent among my hon. Friends, all of whose speeches merit re-reading—and all of whom supported the amendment.
    The other distinguishing characteristic of the debate has been the fact that no Labour or Liberal Member has risen to my challenge to defend the perverse consequences of this measure. I asked them whether they felt that they had been elected to introduce legislation that increased the tax on small business people and reduced it on the rich. I asked whether they supported measures designed to ensure that those who made modest gains paid more tax than those who made large gains. None of them rose to support that aspect of the Bill. We look forward with confidence, therefore, to their joining us in the Lobbies to support the amendment, which would largely eliminate the perverse consequences of the legislation. 379 The issue of consultation, and the inadequate way in which it was carried out, has been raised. The Financial Secretary could not answer the question from my hon. Friend the Member for Bognor Regis and Littlehampton (Mr. Gibb), who said that, if the reforms that the Government wanted to announce and consult about would make life easier for people by reducing the burden of tax and by reducing the burden of compliance with that tax by simplifying it, why should anyone want to pre-empt the introduction of that regime and escape from it? She could not answer, because the question does not permit of an answer that would justify the Government’s lack of consultation.

    The Government could have presented their proposals and allowed people to comment on them without provoking great pre-emptive action by taxpayers. The legislation would have been all the better if they had proceeded in that way, rather than asking people to write in with abstract essays giving their own ideas about capital gains tax, which would be largely ignored.

    The hon. Lady did not respond adequately to our argument that this was in essence a wealth tax. The abolition of indexation and the retention of a positive rate of CGT even after 10 years mean that anyone who has gains that purely reflect the decline in the value of money will henceforward have to pay tax on that, and will in effect be paying a wealth tax. Previous Labour Governments tried to introduce such a tax, and this Government will do so.

    The hon. Lady said that a zero rate would be unfair to those who had no capital gains. However, those who have only inflationary gains have no real capital gain. Nothing is more unfair than taxing people on an inflationary gain. The only way to avoid that is by going down to a zero rate.

    On simplification, the hon. Lady reminded the Committee that my hon. Friend the Member for Cotswold (Mr. Clifton-Brown) raised the fact that people already faced the problem of dealing with self-assessment. They will now have the added problem of dealing with tapering as well as indexation. The Financial Secretary said that taxpayers should be taking professional advice to deal with indexation, so it will not be difficult for them to take additional professional advice to deal with tapering.

    My right hon. and learned Friend the Member for Sleaford and North Hykeham (Mr. Hogg), who is talented and numerate, could probably do those calculations in his head, with his eyes closed. He does not need professional advice, but he admits that he would need such advice to deal with tapering. Why should we create a system that will line the pockets of accountants by making indexation and tapering run side by side for anyone who has assets acquired before 17 March?

    As I understand it—perhaps the Financial Secretary will intervene if I am wrong—indexation will not cease in 10 years. It will run alongside tapering for ever in respect of assets acquired before 17 March 1998, so knowledge of the two systems will be necessary.

    Mr. Gardiner The right hon. Gentleman considers it complicated that the two systems should run alongside each other in perpetuity, but his hon. Friend the Member 380 for Guildford (Mr. St. Aubyn) suggested that there should be an option to choose between the two systems. Would that not create even more of a headache?

    Mr. Lilley It would not create more of a headache for those who did not want to take the option. If people wanted to take it up, fair enough. Such systems have existed in the past, but we would prefer not to need the option, by phasing out indexation more satisfactorily and backdating tapering to compensate for it, if that can be done effectively.
    The hon. Lady was blasé about the problems raised by the software houses with regard to coping with the complexities of the tax. The software houses do not lightly say that the problems cannot be dealt with by existing software packages, because those do not contain the necessary information and because much of the information about how the tax will operate is not being made available to the general public. I hope that she will look carefully at the problems and do something about them.

    Retirement relief is one of the most important issues. The Financial Secretary failed to answer the question about the perverse effect. Suppose someone makes a profit of less than £500,000—say, £350,000—perhaps by selling a business which he has run, effectively, to provide him with a pension. We know that £350,000 will buy a pension much the same as the hon. Member for Bolsover (Mr. Skinner) will get when he retires. That person, however, will have to pay more tax. By contrast, someone who sells a business for £2 million will get an extra £350,000, more than he would get under the present tax regime, so he will be able to buy a second Bolsover pension for himself.

    Is that sensible? Were Labour Members elected to bring about a change that will make the rich richer and the less rich less well off? To those that have shall be given, and from those that have not shall be taken away—that seems to be the motto of those on the Front Bench, which is calmly accepted by Back-Bench Labour Members.

    After much effort, the hon. Lady said that she now believes that, in the long run, her tax changes will be fairly neutral. I do not know anyone outside the Committee in the expert community who believes that that is so. Almost all of them think that the changes will enhance Government revenues. They would be equally doubtful about her suggestion that moving to a zero rate would have an impact on the yield as substantial as she suggests. I would welcome the publication by the Government of the way in which they have made their calculations in this respect.

    Most surprising of the Financial Secretary’s replies to the questions raised was her statement that the perverse interim consequences of the transitional arrangements were deliberate. A person who in three or four years sells an asset that has risen at about 5 per cent. in money terms, assuming that inflation stays at its present level, will pay a 60 per cent. rate of tax on his real gain.

    The hon. Lady says that that pattern of rates on gains made in the interim is intentional, and that it is designed to encourage people to hold on to their assets even longer. Why does she not make the rate 100 per cent., and make people pay massive rates unless they keep their assets for a very long time? It is extraordinary to increase the 381 effective rate of tax on real gains where those gains are modest. It is way above the present 40 per cent. rate. I am surprised about that.

    On the 30-day rule, the Financial Secretary had no answer to the pertinent question why it was good for someone to be able to sell Glaxo and the next day to buy Beechams, but wrong for that person to be able to sell Glaxo and buy Glaxo back the next day, and make use of his capital gains tax allowance. Until we get an answer to that question, we will be puzzled why this strange dog’s dinner—or dog’s breakfast—of a measure had been introduced.

    We will urge the Committee to vote in favour of the amendments, confident that the silence of Labour Members signifies consent on the perverse consequences of the Government’s proposals, and that we will have a large measure of support from Labour Members.

    Mr. Clifton-Brown If, as the Government believe and the Financial Secretary made clear, these complex changes are revenue-neutral in the medium term, what on earth is the point of introducing them, when the compliance cost will be hugely increased?

    Mr. Lilley That is a very good question. A system that does not achieve the simplification that might have been possible if indexation had been replaced by indexation leading to a zero rate is probably not worth having. If the measure does not raise extra revenue, it is hard to justify. However, one suspects that it will—like almost every other tax measure that the Government have introduced. It is another tax-raising measure, from a tax-raising socialist Government. We urge the Committee to support us in this amendment.