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Wednesday, 18 March 2009

Much Ado about Nothing

It is not often that we see a politician so blind to his own flawed logic, but this morning Nick Clegg of the Lib Dems gave us the benefit of his own stupidity by complaining that banks should not be entering into tax avoidance arrangements whilst receiving bail outs from the tax payer.

He really doesn't get this money thing does he? The specific case in the news was Barclays, who haven't actually formally asked the government for help, but the principle is the same for the banks that have.

Banks have gone to the government for help, or the FSA has told them they have insufficient Tier 1 capital, in order to continue operating. Tax savings put extra funds directly into Tier 1 capital by adding to retained earnings. Once banks have given up and gone to the government for help it makes little difference to the capital position whether any additional funding comes from tax savings or from equity injected by the government. A £1 saved in tax is a £1 less equity required from the government. The only difference is ownership of the bank. The more cash the government puts in, the higher the stake in the company held by the government.

So what Clegg is saying, although he is probably not smart enough to realise it, is that rather than entering into perfectly legal arrangements to minimise their tax, directors of banks that have gone to the government for help should forego those savings and pay more taxes, reducing their capital and requiring more cash from the government. It doesn't save the government a penny, but hands over more of the shares in the bank to the government.

This logic only applies to banks that have gone to the government for help. Mr Clegg doesn't seem to think the same way about banks that have not gone to the government for help, where there is a potential increase in net Treasury receipts from reducing tax avoidance.

Others have said that banks should not be promoting tax avoidance schemes to their clients, which I discussed yesterday. But this argument may also be flawed. At a time when the government is keen to see the economy boosted, there is little point in trying to extricate cash from profitable companies who have entered into legal transactions. The cash is in the productive economy in the hands of a profitable company whom one would hope has a chance of employing the extra cash productively.

The alternative would be to pay taxes to the government to be redeployed as the government sees fit. I honestly think the evidence is that the cash would be better used and more growth created by the private sector, and it is not worth the government time and effort to change the situation. Clegg and the illiberal Lib Dems may relish the prospect of more cash flowing through the government coffers, but from outside Westminster it just looks like a pointless exercise.

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