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Sunday 22 November 2009

Cameron’s calculated risk to tax the rich may not add up

The City of London is arguably the juiciest tax target in Europe.

The City of London is arguably the juiciest tax target in Europe. Replete with lavishly rewarded financiers creating extraordinary amounts of wealth, it seemed inevitable that the politicians would eventually come after it. The only surprise is that it was the Conservatives who have done so first.

A £3.5bn ($7.2bn, e5bn) raid on non-domicile workers has become the centre piece of the Tory manifesto, allowing David Cameron to embrace a “tax the rich” agenda with a minimum of political damage. Few will shed a tear for the non-doms, while the decision to use this money to raise the inheritance tax threshold from £300,000 to £1m packs an incredibly powerful political punch. So the political theory makes sense, even though the scheme is doomed in practice.

Britain’s population of non-domiciles are a tiny group and (by definition) mostly foreign. They have no spokesman, no pressure group and precious few friends. Even in the City, you can find lingering resentment: British financiers who work alongside non-doms deeply dislike the fact that their take-home pay is so divergent. This “squeeze the rich” attitude can be found even among the wealthy.

The Conservatives claim to have the blessing of non-doms for the annual £25,000 flat tax they propose to charge (which, they say, Americans can reclaim after tax). It is a small price, says David Cameron, to pay for the knowledge that the tax man will not start to hunt down their overseas income and tax them on that.

Cameron’s fans argue that at last non-doms will start to pay their way, but no one mentions the average non-dom already hands £26,000 to the Treasury, covering the cost of the few services they use many times over.

While only 7% of estates pay inheritance tax, the political impact is magnified by a variety of factors. Millions do all they can to avoid the taxman, depressing the numbers who actually pay. Fear of inheritance tax stretches down to those who are not rich, but worry that their house price has risen so much they may not be able to plan for those who succeed them. There are several would-be beneficiaries to every elderly saver and homeowner – and they all vote.

And the government’s approach to inheritance tax – “what do you care, you’ll be dead anyway” cuts against the grain of human nature. The life insurance industry and environmental movement are both rooted in the fact that people do care, deeply, about what follows them.

When the Daily Express ran a campaign against the death tax, to use their more emotive term, there were more signatories than the newspaper had readers. This issue cuts deep, for reasons that don’t show up on a spreadsheet.

But will the non-doms pay for all this? The honest answer is that no one has a clue. There is a dearth of public information, and the Tory proposal is a stab in the dark. Its premise, for example, is that there are 150,000 non-doms. There were 112,000 in 2004/05, the latest data they had available, and they assumed an exponential rise. They also assumed that the average non-dom has overseas earnings way over the £100,000 they earn inland. The figure the Tories worked with was £250,000.

Staggeringly, and in breach of constitutional principle, the Treasury itself gave the Labour Party ammunition with which to rebut the Tory proposal – and in doing so lifted much of the mystery about non-doms.

There are only 60,000 of them with overseas earnings over £100,000, it says – a figure which the Treasury claimed as recently as April did not exist. Most strikingly, Labour also disclosed that there were 114,000 non-doms in 2005/06. So the boost the Tories imagined simply does not exist. Their chances of raising £3.5bn are thus very slim.

The biggest problem is a psychological one: if it were so easy to raise extra revenue from the non-doms this way, why would this not have been done by Gordon Brown, who during his tenure at the Treasury became the most tax-greedy Chancellor in the history of these islands? He has cast his slide rule over them many times, but each time the now Prime Minister argued it was best not to roast the goose which lays the golden eggs. The City works, it pays tax – so best not mess with it.

As Brown well knows, the City is not so much a finance centre as a financial refugee camp. The Sarbanes-Oxley legislation has seen overseas firms listing here. European tax raids and regulation has sent German, French and Italian financiers here. They come because other countries have underestimated the mobility of global finance. Brown is painfully aware that the non-doms are not sitting ducks, but flying ducks who take fright at the first sign of the intrusive taxman.

In a way, it does not matter that the Tories’ plans do not stack up. Should they win an election, the state will be gorging its way through £520bn in annual expenditure.

There is ample scope to squeeze a billion or so out of this: there is no need to tax the City. But previous “what if” analyses looking at non-doms estimated 20% would leave if they were taxed more highly. The Tories optimistically put this at zero. Should they take power, an upset to the magical balance of the City may be one of the highest risks they face.