Serious Money

March 25, 2011 7:12 pm

Throwbacks to the past to drag us into the future

Angostura bitters and enterprise zones. Just the  names make you nostalgic, don’t they? But which of these throwbacks to previous decades are now past their sell-by date? Both, it would seem, judging by the reform of tax reliefs announced in this week’s Budget.

It was in the late 1970s that I first remember discovering the small crusty bottle wrapped in an oddly oversize label at the back of my Dad’s drinks cabinet, and wondering why anyone would want to put anything made from apparently bitter herbs into a perfectly pleasant drink. No one at our house ever seemed to, as the bottle looked as if it hadn’t been opened since about 1968. It was only recently that I discovered that the bitters date back a lot further (having been created in Venezuela in 1824), are still in use in certain bars in Scotland (where they are integral to long vodka – a more manly, and deadly, equivalent of pink gin) and carry 100 per cent tax relief (which, knowing my Dad, is the most likely explanation for his investment in a bottle). However, faced with a £146bn budget deficit, the chancellor has called time on tax-efficient cocktails: tax relief for Angostura bitters is to be abolished in 2012.

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And it was in the early 1980s that I first remember seeing Michael Heseltine on TV, looking oddly oversized standing in front of small, grimy buildings – and wondering if anyone would put money into making things in Corby, Hartlepool or any other industrial wasteland. Not many people seemed to, as only Canary Wharf looked vaguely like it might be open for business by 1988. Again, it was only recently that I discovered that enterprise zones date back further (having been devised by academic Sir Peter Hall in the mid-1970s), are still in use in parts of England (where they have been extended for additional 10-year periods to allow long-term property investment), and carry 90-98 per cent tax relief (the explanation for that property investment). However, faced with lower economic growth forecasts, the chancellor has decided to revive the 1980s without the excess: 21 new enterprise zones will be created but the commercial property relief ends this year.

But, in getting rid of these tax reliefs, while boosting others, the chancellor has arguably signalled a return to even more old-fashioned values – the principle that the tax system should give more incentive to those investors who take more risk and do more good.

In fact, with the upfront tax relief on Enterprise Investment Schemes (EISs) increasing, and pension contributions with tax relief being cut, all the UK’s tax-incentivised investments are arguably now in the right order on a sliding scale, with relief decreasing in proportion to risk and socio-economic benefit.

1. EISs. Highest annual investment limit of £1m, with 30 per cent tax relief just like Venture Capital Trusts (VCTs) – which is only right, given that the qualifying investments are small unquoted companies that cannot be easily sold, researched or tracked in terms of performance. But their value to the economy is potentially the greatest, as many are focused on high-growth sectors.

2. VCTs. Lower annual investment limit of £200,000 but the same 30 per cent tax relief – which reflects the relatively lower risk of funds that are stock market-listed, giving an exit route for investors. Their value to the economy is perhaps less than that of pure growth EISs, as many VCTs now back businesses with secure revenues and assets, but significant nonetheless.

3. Pensions. Lower annual investment limit of £50,000 but with tax relief at the investor’s highest marginal rate, ie up to 50 per cent – which reflects the fact that pension assets can be diversified across asset classes. Their value to the economy is in cutting the cost of means-tested state benefits.

4. Individual savings accounts. Lowest annual investment limit of £10,200, with no upfront tax relief but tax-free capital gains and interest – which reflects the fact that they largely hold cash and managed funds. Their value to the economy is in improving the savings ratio and boosting pension provision.

This long-overdue re-ordering is to be commended. However, simply giving private investors a tax carrot or a stick is a little too dated. Isn’t this the government that believes in the “Nudge” – the principle of making beneficial actions the easiest or default option, as espoused in the behavioural finance bible of the same name by US academic Richard Thaler?

If so, the administrative hassle of getting money into EISs and VCTs, claiming back the tax relief, and seeking information or research on investee companies needs to be simplified – with less onus on the individual and more support from advisers and managers. Then we might all develop a taste for this good old-fashioned growth recipe.

matthew.vincent@ft.com

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