4
BUSINESS
Gulf spill poured cold water on Prudential deal
AGENDA
hurdle in the Pru’s way. The gulf spill
wrecked BP’s share price and corporate
reputation, and helped derail the Pru deal.
The big question now for both of them,
even if Hayward won’t countenance it
while the oil is still leaking, is whether
they can hang on to their jobs. At the Pru,
investors are hungry for a sacrifice. They
voiced their opposition to the deal early on,
were cajoled into supporting a cut-price
version and let down at the eleventh
hour. Thiam and Harvey McGrath, the
chairman, will put a brave face on the
saga at the annual shareholders’ meeting
tomorrow, and will say sorry. That is
unlikely to be enough.
While Thiam is most likely to get the
push, some shareholders are quietly
pointing the finger instead at McGrath,
saying the whole board voted in favour of
the AIA purchase, and that the failures in
communication and investor relations
can be laid at his door. Nothing is likely to
happen quickly, with the Pru’s interim
results in August the next milestone.
Hayward has no problems with his
shareholders. His trial is in the wider
court of American public opinion. He
may have to go simply to help restore the
BP brand in America. BP’s directors —
including Hayward himself — took a
deliberate decision to make him the focal
point for the Gulf of Mexico disaster.
Fielding the chairman, Carl-Henric
Svanberg, would only have confused
matters, they reasoned, as Americans
don’t understand the division of roles in
Britain between chairman and chief
executive. It was probably the right
DOMINIC
O’CONNELL
BUSINESS EDITOR
n Friday I met two under-fire
chief executives. BP’s Tony
Hayward looked tired and
defiant after 45 days fighting a
company-threatening oil spill
in the Gulf of Mexico. Tidjane Thiam at
Prudential was cool and amiable, but also
angry after having his cherished
$30 billion Asian deal torpedoed at the
last minute.
Corporate Britain has rarely seen the
kind of drama that has engulfed these
two. Hayward has become the face of an
environmental disaster that is one of the
global stories of the year. Thiam has
tried to steer one of the largest takeovers
attempted by a British company through
a minefield of hostile regulators and
critical shareholders — and failed.
Both face calls to resign. Hayward
won’t even entertain the question, saying
he hasn’t read a newspaper in weeks and
O
has only one thought in his mind,
capping the gulf gusher. Thiam says he
considered stepping down, thought
better of it, but will go if shareholders
make it clear they want him out.
The troubled chiefs are linked by more
than both being put through the mill in
recent weeks. At the end of April, when
Thiam was preparing the purchase of
AIA, the Asian arm of AIG, the American
insurance group, markets were in a rare
patch of calm. Then came the Gulf
blowout, which hit BP shares hard.
Eventually nearly one-third was wiped
off the oil group’s valuation, just when
Thiam was asking his institutional
shareholders for support for the
£14 billion rights issue he needed. Many
of the institutions would have paid for
the rights by selling part of their holdings
in BP. With its price on the floor, they
were reluctant to do so, putting another
decision in public relations terms but
when it comes to the crunch it means
there is only one name in the frame.
Question time
IN More Money than God, his book on
hedge funds, the American author
Sebastian Mallaby quotes Paul Tudor
Jones, the fund manager, on why the
American government was powerless to
stop a market crash in the wake of the
Lehman Brothers collapse. “The question
mark would totally create financial panic
and chaos,” Jones said. The question
mark he was referring to was the
uncertainty created when cracks begin to
appear in the facades of institutions. If
Lehman had gone, why not Goldman,
Merrill Lynch or any other bank?
We are reaching a similar position on
sovereign debt. First came Greece, then
Portugal and Spain. Now the question
mark is hovering over Hungary and even,
if you believe some bloggers this
weekend, France. The euro is now at a
four-year low against the dollar and
François Fillon, the French prime
minister, didn’t help its cause when he
said on Friday that he saw only “good
news” in having parity between the two
currencies. To get to parity, the euro
would have lose about one-sixth of its
value. If one of the eurozone countries is
forced to default on its loans, with Greece
being the obvious candidate, Fillon may
get his wish sooner than he expects.
The G20 has this weekend done its best
to shore up confidence in sovereign debt,
Solutions to the taxing
issue of capital gains
ROBERT
CHOTE
Tax from
capital
gains ...
... and where
it comes
from
ECONOMIC
OUTLOOK
CGT receipts
he Institute for Fiscal Studies was
founded in the late 1960s largely
out of frustration with the way
capital gains tax (CGT) was
designed and implemented in
Britain. Over the subsequent four decades
CGT has been attacked, substantially
reformed and attacked again roughly every
10 years. Our new government is only the
latest to try its luck.
The coalition has promised to “seek
ways of taxing non-business capital gains
at rates similar or close to those applied to
income, with generous exemptions for
entrepreneurial business activities”. This
suggests the tax rate on assets such as
shares, second homes and works of art
could rise significantly.
The Liberal Democrats see this as a good
way to raise money for income-tax cuts,
but also as a move back towards the rational CGT regime put in place by Nigel Lawson
in 1988. However, some backbench Tories
see it as an attack on the middle classes and
a betrayal of Conservative values. David
Cameron has told critics to “calm down”
until they see the details.
At first glance, CGT looks unimportant.
It is forecast to raise £2.7 billion this year —
just 0.5% of the Treasury’s total revenue.
Some critics argue from American and British experience that increasing CGT rates
would actually cost the government revenue, but swings in CGT revenues from year
to year often reflect the pre-announcement
of rate changes and expectations of where
they might go next. And we should not
look at CGT revenues in isolation: perhaps
the key role of the tax is to underpin the
much bigger revenues we get from income
tax and National Insurance.
CGT is applied to the increase in the value of an asset between its acquisition and
disposal. This sounds simple, but the devil
lies in the many attendant details. For
example, to which assets should it apply?
Which part of the gain should you tax? And
should the tax rate be uniform or vary with
the type of asset, the length of time it has
been held or the income of its owner?
Different chancellors have answered
these questions in different ways. When
James Callaghan introduced CGT in 1965, it
was a flat rate of 30%. Geoffrey Howe introduced indexation allowances in 1982, ensuring that only gains in excess of inflation
were taxed. In 1988 Lawson began taxing
gains at the taxpayer’s marginal incometax rate. This was probably as good as it got.
Gordon Brown abolished indexation
allowances for gains after April 1998 and
introduced “taper relief”. This gave taxpayers an increasingly generous discount on
their CGT bills the longer they held the
assets (with a bigger discount for business
assets than non-business ones). He made
taper relief more generous in 2000 and
2002, before Alistair Darling announced in
2007 that he would abolish the relief and
impose a flat rate of 18% — returning to the
pre-1982 system. Business lobby groups
complained that this would increase the
rate paid on long-held business assets, forcing him to create “entrepreneurs’ relief”,
Gains subject to
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which cuts the rate to 10% on the first £1m
of lifetime gains for some business assets.
Looking back, most of these changes
have been attempts to balance two competing objectives: the desire to minimise the
scope for tax avoidance created when capital gains are taxed more lightly than
income, and, second, the desire to keep capital taxes as low as possible to avoid discouraging saving and investment. The now
Lord Lawson and the Liberal Democrats
put more emphasis on the former, while
the last Labour government and the current Conservative critics of the coalition
put more on the latter. These critics also
argue that many small investors have been
saving in non-business assets in the expectation of generous tax treatment and that
it would be unfair to withdraw it now.
The Liberal/Lawson view has much to
recommend it. The tax system should not
distort people’s behaviour in a costly way
without good reason. From this several lessons follow.
First, the tax rate on capital gains should
be aligned with the rates on earned and dividend income, ideally with a single tax-free
allowance. Different tax rates encourage
people to be paid in more lightly taxed
forms and to move into occupations where
this is easier. Using anti-avoidance rules to
restrict how people are paid in particular
circumstances is much less attractive.
Second, CGT should not discriminate
between business and non-business assets.
People should be left to decide unbribed
whether to put their money into a bank
account, housing, shares, or into their own
businesses, based on their own judgment
of the risks and returns involved. There is
an argument for taxing shares more lightly, however, because company profits that
give rise to capital gains have already been
subject to corporation tax. We should be
wary of the argument that investing in
one’s own business is a virtuous act deserving of subsidy in a way that investing in
somebody else’s business is not. People
should decide whether and how to build an
enterprise on the basis of its commercial
fundamentals, not its tax treatment.
Third, we should not try to bribe people
into holding assets for longer than they
would otherwise wish to do — economic
welfare is best served by having assets
owned by the people who value them most.
The previous government justified taper
relief as a way to discourage short-termism,
but encouraging people to hold assets for
longer than they want is not the same as
encouraging companies to undertake productive investments that may take a long
time to pay off.
Fourth, we should tax real gains rather
than the illusory gains from inflation, so
there is a strong case for reintroducing
indexation allowances.
But what of the twin objections that all
this would discourage future investment
and penalise past saving?
High CGT rates certainly discourage
investment, but reducing them is not necessarily the best way to encourage it. Capital allowances, including schemes such as
the Annual Investment Allowance aimed
at small firms, are more effective ways
because they specifically reduce the tax
rate on capital investment rather than on
the other factors that generate capital
gains. But the Conservatives want to
shrink capital allowances to help pay for
cuts in the main rate of corporation tax.
An alternative approach would be to
reintroduce indexation allowances, not
just for inflation but also for the minimum
return that someone would require to
invest a pound today rather than spend it.
This would move us closer to an “expenditure tax” system that would not distort levels of saving and investment, especially if
accompanied by similar changes to income
tax and corporation tax.
Aligning CGT and income-tax rates
more closely would, of course, anger people
who have been saving in assets that currently attract generous tax treatment. But
there was never any guarantee that this
preferential treatment would remain in
perpetuity, especially given the regularity
of CGT changes in the past. Various possible transitional arrangements could ease
the pain, but all would be costly, complicated and of questionable fairness.
The uncomfortable truth is that the coalition partners will have to inflict a lot of
pain and disappoint quite a few expectations over the next few years as they clear
up the fiscal mess they have inherited
from Labour. Hopefully they will have the
courage to move towards a more rational
tax system as they do so, rather than simply scrambling from one short-term fix to
the next.
n Robert Chote is director of the
Institute for Fiscal Studies
David Smith is away
praising the eurozone countries for the
safety net they have put in place to rescue
stricken members. That doesn’t erase
Jones’s question mark, however. The only
thing that will is evidence that austerity
programmes are biting, and debt is
coming down to manageable levels.
Derailing bonuses
THE railways are a seasonal business. In
autumn, there are leaves on the line and
in winter it’s the wrong kind of snow.
Summer brings the controversy over the
executive bonuses at Network Rail,
which owns and maintains the network.
Despite being an odd corporate animal,
€ 1.55
Euro/dollar
1.45
1.35
1.25
1.15
SOURCE: Yahoo
2009
2010
with no shares and loans borrowing
guaranteed by the government, Network
Rail has a quoted, company-style
remuneration scheme, which hands out
bonuses of up to 100% of base salary.
Politicians, unions and, sometimes,
passengers don’t like the idea, saying it’s
not right for a company that relies on
taxpayer support to pay such sums, and
in any event my train was late yesterday,
and what are they doing about that?
The decision on payouts will be made
at the end of the month. Already the
opening shots have been fired. Philip
Hammond, transport secretary, last week
fired off a letter to the directors saying
they should bear in mind the general
mood of public sector restraint before
loosening the purse strings. Network
Rail, meanwhile, is talking up its record,
perhaps in an attempt to forestall
criticism if it does pay out. Iain Coucher,
the chief executive (who has a base salary
of £613,000) says the company is making
big savings, and improving reliability.
The company’s regulator has some
nice things to say about it, but feels it’s
too early to judge on the crucial point of
efficiences. “At this stage it is not clear to
what extent Network Rail has made real
progress to deliver this requirement,” is
the lukewarm conclusion. With the
regulator not standing by the company
and the secretary of state giving it a clear
warning, the remuneration committee
should think twice before handing out
any bonuses.
dominic.oconnell@sunday-times.co.uk
All we can see
is the clouds in
the silver lining
he bad news is that there is a lot
of bad news. BP, known to our
president as British Petroleum,
is destroying the ecology of the
Gulf of Mexico, and wrecking
the economies of the states that abut it.
The eurozone is in a state of chaos as
profligate nations prove unable to repay
the money they have borrowed, creating
the possibility of another collapse of the
international financial system.
Tensions in the Middle East and on
the Korean peninsula are rising. Japan’s
prime minister has resigned, as has
Germany’s president, unsettling the
political picture in both countries, not
good news for those hoping for robust
recoveries in the world’s second and
fourth-largest economies, respectively.
China’s economy, the third largest,
seems to be overheating. Iran’s effort to
go nuclear proceeds, unimpeded by UN
resolutions or sanctions.
Meanwhile, the American economic
recovery is experiencing a wobble. Only
41,000 of the 431,000 non-farm jobs
created in May were in the private
sector, and perhaps 20% of those, by one
estimate, were to help clean up the oil
spill. The government hired 411,000
temporary and low-paid census takers,
bringing the total knocking on doors to
564,000. They will soon return to the
unemployment rolls or part-time work.
No surprise that share prices plunged
when the bad jobs news was released.
Still, there are signs that the recovery
has not flamed out. The Organisation for
Economic Co-operation and
Development expects the American
economy to grow at an annual rate of
3.2% this year and next. Consumers’
incomes rose in April, and it is hardly
bad news that they decided to save the
increase rather than step up spending.
Besides, their refusal to spend comes not
because of any new gloom: confidence
actually rose last month to its highest
level in two years as consumers reported
that their view of the future has become
cheerier. A survey by Deloitte found that
nearly two-thirds said their financial
circumstances were as good or better
than last year. Which might explain the
big jump in car sales in May.
President Barack Obama’s plan to
double exports in the next five years is
more a campaign talking point than a
realisable goal, but exports are picking
up. The Institute for Supply
Management reports they are at their
highest level since 1988. Those export
sales helped the manufacturing sector
achieve its tenth successive month of
growth. The president of Cyril Bath, a
manufacturer of machines used in the
aircraft industry, told The Wall Street
Journal: “We’ve got orders coming in
from Europe. We’ve got orders coming
in from Japan, China, India and Russia.
They’re coming in at record levels . . .”
Rational exuberance, one hopes.
It is, however, not for nothing that
economics is known as the dismal
science. In addition to very weak job
growth, economists note that estimates
of fourth-quarter 2009 GDP have been
revised down from 3.2% to 3%. The
gloomier ones also point out that
consumer confidence often rises and
falls with the job market, and the low
level of job creation last month, plus
the inevitable lay-offs when the
census-taking is completed, will soon
wipe the smiles off consumers’ faces.
Worse still, economists cannot decide
whether to worry about deflation or
inflation. With prices already edging
down, substantial excess capacity in the
system, and euroland about to withdraw
large amounts of demand from the world
economic system as austerity bites, it is
T
IRWIN
STELZER
AMERICAN
ACCOUNT
reasonable to worry that a Japanese-style
deflation is in America’s future. That sort
of thing is hard to reverse: knowing that
prices are declining, consumers defer
purchases, which causes prices to fall
further, which in turn causes consumers
to keep their wallets and purses zipped.
Result: recession.
Others fear just the opposite. With the
government running huge deficits, and
the Federal Reserve printing money, we
will have an inflationary spiral, with the
value of the dollar declining, savers
devastated, and interest rates soaring
as investors demand higher and higher
rates for their money, knowing they will
be repaid in dollars with reduced
purchasing power. This explains the
flight to gold, widely believed to be a
hedge against inflation.
Or, if you prefer your “dismal” to be of
the imported variety, the tale of woe goes
like this. The declining euro, headed
perhaps to parity with the dollar, will
stifle America’s export business. And
Europe will also send over a financial
crisis, as its banks take big losses on
sovereign debt and on loans to Greek and
other enterprises. Already, banks are
hoarding money, threatening a seizing
up of credit markets on a scale not seen
since the collapse of Lehman Brothers.
And companies have decided to rein in
borrowing, given the uncertainties in
credit markets.
Then there are home-grown policy
developments to worry about. The
financial reform bill that will soon end
up on the president’s desk, whatever its
merits, and there are several, will create
a bakers’ dozen of new regulatory
agencies, according to my Hudson
Institute colleague, Diana FurchtgottRoth. It is not likely to produce an
optimally efficient financial sector. Tax
increases are scheduled to hit soon after
the November congressional elections,
costly regulations are being imposed on
the resurgent car sector, and estimates of
the cost of what has come to be called
Obamacare rise almost every week.
These are all reasonable worries, but
all a bit overblown. The more likely
outlook is for a continued recovery,
though the pace is uncertain. The
Federal Reserve is now unlikely to
implement any exit strategy it might
have, keeping interest rates low.
Congress is even less likely to pull the
trio of artificial props — Fannie Mae,
Freddie Mac, Federal Housing
Administration — from under the
mortgage and housing markets.
And a new stimulus bill is certain to
precede the November elections. So
growth there will be, barring any
shocks to the system. Which, of course,
are not out of the question in this very
uncertain world.
n Irwin Stelzer is a business adviser and
director of economic policy studies at the
Hudson Institute
stelzer@aol.com