Charlie Brown like Gordon Brown was a pessimist when it came to pensions.
I think this conversation is important. Companies pay tax on their profits and they then pay dividends out of their taxed profits. That means the dividend was calculated after tax. Advance corporation tax gave you credit for the tax paid by the company. Gordon Brown took away the corporation tax credit, effectively taking away tax relief on dividends.
Con Keating reckons that this is creating a £5bn credit to the Treasury today.
But the shift in pensions from UK to overseas equities began when Gordon Brown disincentivised investment in UK growth and is now giving the Treasury a lot of problems.
This was nothing to do with the shift from growth to risk- matching that occurred after the Pensions Regulator enforced what Government demanded to de-risk pensions.
The irony is obvious when the two documents are so well set out by David. A quarter of a century on we realise that we have de-incentivised the holding of UK equities and as a result have considerably less “effective investment” from our £5tr om UK pensions.
It’s doubly ironic that it was a Labour Chancellor who implemented the taxation of dividends on growth assets (equities).
It’s trebly ironic that it was Gordon Brown’s prime minister Tony Blair’s institute that brought this matter up in 2023 and perhaps alerted Conservative opposition prime minister Kemi Badenoch to the own goal.
Saying this does not help very much to make things better. It might spark a debate in the Treasury where there are now civil servants with no responsibility for what was done in 1997. They might think that now is the time to start putting things right , getting more UK equities, more growth stocks (whether listed or unlisted) into pension funds that can afford to own patient capital.
I don’t suppose that we will see again DB schemes invested in UK equities to any great degree, but I see our DC schemes of which part will be CDC, investing in the long-term. I will point out to anyone who is listening that if we want to take risk onboard, we need to have an appetite for patient capital and that means infinite time horizons for the majority of growth capital. That won’t happen overnight, it has taken 25 years to get from growth to defensive risk-matching investment strategies. It need not take that long to get back that way.
Tax does make a difference, it may not be the way to go, to deduct tax-relief from funds that don’t go for growth in the UK , but it seems much more acceptable to encourage investment in UK equities by returning to allow pension schemes to collect dividends tax-free. It seemed to work very well before Gordon Brown changed tax strategy.
The 1997 abolition of Advance Corporation Tax recovery by pension schemes was a mismanaged policy implementation. ACT was a withholding tax (20% in 1997) on dividend payments from UK tax resident companies. The tax paying company could deduct the ACT from its mainstream Corporation Tax payments so overall it ended up paying the same Corporation Tax as it would have done if it had not paid a dividend. A registered pension scheme investor, along with charities and various other tax exempt organisations could claim a tax credit on its UK sourced dividend income to put in the position it would have been had the ACT not been deducted.
The problem from the Treasury’s point of view was that the tax credit was not matched to the Corporation Tax relief claimed by the dividend paying company. This led to an abuse of the system with loss to the Exchequer. I dealt with a situation where the tax credit was legitimately paid to two non tax paying entities on a dissolution dividend from a joint venture company that had never paid any Corporation Tax. You can perhaps see how the unscrupulous could manipulate this system.
While Gordon Brown as Chancellor stopped the tax credit in 1997 he abolished Advance Corporation Tax in 1999. Therefore after 1999 pension schemes were notionally in the same position as they were in prior to 1997.
Needless to say, the 1997 Conservative opposition made hay on the issue by pointing out that the reduction in the dividend yield from UK companies from the loss of the tax credit had added significantly to the pension scheme liability valuations which at that time used UK dividend yield in the discount rate. Sponsoring companies therefore saw this as a tax raid on their pension schemes out of all proportion to the actual cash effect.
Once ACT was abolished in 1999, a company’s capacity to pay dividends was restricted by its liability to corporation tax without the ACT setoff resulting in a reduction in gross dividends and the dividend yield. Highlighting the fact that prior to 1997 the Exchequer had been topping up the dividend income to Pension Schemes by up to 20%. I noted that in the New Capital Consensus event that someone did suggest the reinstatement of this fiscal subsidy to pension schemes.
From the pension scheme’s point of view this put dividends from UK companies on the same footing as overseas companies which have traditionally paid lower dividends (current FT 100 dividend yield c.3.1% vs. c.1.5% on MSCI World). This led to a switch in emphasis by pension funds to revaluation yield from dividend yield, increasing use of accumulation funds and cash flows generated by disinvestment and therefore subject to greater market value risks. Also a greater reliance on income from bonds despite the long term term stability of equity dividends (the fall in the FT 100 average dividend yield over the past 20 years reflects the increase in the market price of the shares and total cash dividend growth has largely matched inflation).
Unfortunately we do not seem to learn lessons.
– We still compare market values of investments to liability measures unrelated to the actual investments of the Scheme and their capacity to match the cash flows required to pay the benefits as required; whether in DC pots or in DB schemes.
– We still do not sense check our assumptions and stick with rigid rules (e.g. Gilt based liability valuations at times of negative real gilt yields).
– We invest in accumulation funds to the advantage of the asset manager with management charges based on assets under management values even when we are targeting income flows.
We are too keen to buy non public market traded assets without analysing in depth the valuation price and its implicit assumptions.