Dumber than a bag of hammers

The tax proposals outlined by the Tory Shadow Chancellor to the party's annual conference this week are strikingly dumb, as well as being way out of line with the party's presumed "principles". If elected, the Tories plan to reduce the burden of taxation on unearned income (inheritances) while boosting it on earned income (as represented by the demonised "non-doms"). They will also in all likelihood pump the housing bubble up even further. Nice one, George.

The party's distaste for inheritance tax was made clear in the recent Redwood Report, which proposed replacing it with a reformed capital gains tax. As I said at the time, that's not a bad idea. However, the party has gone much further, with a plan to eliminate all inheritance tax on estates of less than £1 million, exempting family homes altogether.

The party claims that it detects a growing level of worry among taxpayers about the widening application of inheritance tax. Actually, it's not the taxpayers who are worried: they'll be dead when the tax comes through. It's the people hoping to benefit from the bequests who are concerned. But should taxation policy be rewritten to exempt almost all bequests? The largest single item that most people pass on to their heirs is the family home. True, people have diligently paid their mortgages in order to own the place; but most of its value is a result of the surge in UK property prices that has resulted from the last deecade and more of low interest rates. The homeowners have not earned it in any meaningful way, and it's hard to make a case that it should be exempted from tax -- particularly when the Tories propose to make up the revenue shortfall by taxing earned income, of which more below.

At the other end of the housing ladder, the Tories plan to exempt all first-time buyers from property taxes on homes sold for less than £250,000. One can only imagine the chicanery this will lead to, as husbands and wives take turns being the "first time buyer" of their first two homes. And it would be naive in the extreme to think that the removal of the tax will do anything except push asking prices higher, eliminating some or all of the hoped-for benefit to buyers.

In a bigger-picture sense, the Tories' pandering to the UK property obsession looks badly misjudged. Property often seems like the main driver of the UK economy and the favoured savings mechanism for a large part of the population, at the expense of more productive investments. (When did you last see a column in one of the weekend money supplements saying "I don't trust the housing markets so I'm putting my money into stocks and shares"?)

If the Tories get their way, there will be no tax on the first-time homebuyer; none on sales of the family home during one's lifetime; and none on the family home as part of a bequest. Can it really be smart to exempt such a key sector of the economy so completely from taxation? The Tories have castigated the Labour Government for making housing unaffordable through excessively cheap credit: it looks like they intend to do the same thing through wildly favourable tax treatment.

What makes this so much worse is that the Tories plan to pay for this needless and dangerous giveaway to homeowners by means of a new flat-rate tax on non-domiciled UK residents. Everyone has been attacking the non-doms lately, and no doubt a tax on them will play well with Daily Mail readers, but does anyone know who they are and exactly how they are treated?

Well yes, actually -- I do. When I returned from Canada to the UK a decade ago, I was given non-dom status. (For what it's worth, I no longer claim it). Non-dom status allows a UK resident to avoid tax on assets held outside the UK and on sums earned outside the UK while resident here. It emphatically does not exempt people from UK income tax: money earned in the UK is taxable in the normal way, and any money remitted from abroad is also fully subject to tax.

For me, the main (in fact almost the only) benefit was that it allowed me to keep my "Canadian" capital away from the UK tax man, on the assumption that I would return to Canada when my assignment in London ended. So here's the first question for the Tories: I was already paying income tax on virtually all of my employment earnings, which I received in the UK. Would I also have had to pay your proposed £25,000 non-dom tax? And given that there is probably a huge number of non-doms in similar positions to mine, and a whole lot more in relatively low-paid occupations, how can you possibly expect to raise £3.5 billion from your new poll tax? Do you really want to drive away the entrepreneurial Europeans who have moved to London in recent years by doing something as ill-judged as this, in order to pump yet more money into the housing sector?

There are sensible things that could be done to reform property taxation, inheritance taxes and the taxation of non-domiciled residents. The Tories are proposing none of them.

I'll pay when I'm dead

I almost feel sorry for John Redwood. His much-touted report on improving Britain's competitiveness runs well over 200 pages, but the only headline in the papers, all across the spectrum of opinion, concerns his proposal to abolish inheritance tax. This actually merits one six line paragraph in the report, around 180 pages in! How did this get to be so important? Only 6% of estates currently pay inheritance tax, and I surely can't be the only person who'd rather pay taxes after I'm gone than pay them now.

In any case, people hoping to get their hands on their parents' dough completely tax-free are likely to be disappointed. What Redwood and his colleagues are suggesting is that capital gains tax should be reformed and then applied to inheritances. This is exactly the system that operates in Canada: death triggers a "deemed disposition" of assets, resulting in the calculation of capital gains which are then subject to tax at the regular rate. Having gone through the execution of the wills of both of my wife's parents, I can attest that this emphatically does not mean that the estate is passed on tax-free.

Redwood's idea makes sense (I can't believe I just wrote that!) to the extent that it represents a more efficient way of dealing with the taxation of estates. Why have a separate and unpopular inheritance tax when you can get the same results through capital gains tax? However, this positive aspect is offset, or maybe even completely outweighed, by his proposal that the value of principal residences should be exempt from all taxation upon death.

This exemption (which also exists in Canada) changes Redwood's proposal from a sensible piece of tax simplification into a blatant sop to the property-obsessed middle classes. It could well have an undesirable effect on the property market: if I can pass on my home without tax, I'm all the more likely to remain overhoused in an unnecessarily large house until I croak, rather than downscaling in my dotage as people always used to do. This can only worsen the existing shortage of larger family homes, and help to push up their prices further.

There's a lot to think about in the Redwood report. Abolishing inheritance tax is neither the best nor the worst idea in it -- and it's certainly not the most important.

Not-so-mighty Redwood

I see that John Redwood, an arch-Thatcherite from the right of the Tory party, is proposing that the party adopts a programme of business deregulation as part of its platform for the next election. One of his proposals is to abolish most regulation of the mortgage market, on the grounds that it's the lender who is bearing the risk.

I suppose it's too much to expect a Tory dinosaur to be up to speed on the derivatives market, but perhaps someone should take the time to explain the current crisis in the US sub-prime mortgage market to Mr Redwood. The problems there have been caused not just by irresponsible (and unregulated) lending, but also by the practice of packaging the mortgages up into CLOs and selling them on to all manner of end investors. As a result, nobody can really be sure who is bearing the risk -- not even John Redwood.