David Green: Wealth extraction, not wealth creation. The Morrisons takeoever – and why government should be prepared to intervene.

11 Jul

David Green is Director of Civitas.

The Government is in a philosophical quandary. Its commitment to levelling up implies economic interventions in favour of left-behind regions. As a result, it has been attacked for abandoning the ideal of low taxes and small government. Simultaneously, it is pursuing some policies that imply continued commitment to the principle of non-interference in economic policy – not least in its approach to takeovers of British companies by private equity, brought to a head recently by offers to buy Morrisons.

The paradox was particularly striking when Kwasi Kwarteng announced new subsidy rules under the Subsidy Control Bill. He felt bound to say that the Government was not returning to the industrial strategy of the 1970s. There would be no ‘picking winners’ or bailing out of unsustainable companies. Producers will be backed only if they have good prospects of success and especially if they are supportive of decarbonisation. An innocent observer might conclude that a policy of avoiding lame ducks and backing promising ‘green’ technologies was picking winners.

The Government appears to have no clear criterion to help it distinguish between policies compatible with personal freedom and those that undermine it. Fortunately, one of the greatest defenders of liberty in the last 100 years grappled with this very problem.

Hayek argued that the main criterion was the rule of law, by which he meant that the Government should act through general laws that applied equally to all, including itself, and specifically that it should not grant preferential treatment to specific people. To do so would undermine the process of competitive discovery by which we reveal better ways of meeting human requirements.

What would this criterion imply for decarbonisation policy? It suggests not pre-judging which producers or technologies will be preferred. In vehicles, for example, there may be a role for hydrogen, hybrids, diesel, petrol, or all-electric. We should allow the competitive system to reveal the best approaches through trial and error.

But what should the Government do about private equity taking over British companies. Must it be accepted as an inevitable consequence of a free market and its ruling doctrine of non-interference?

Again, Hayek thought it through. It was the character of government activity that was important, he said, not the volume. Many measures were compatible with freedom. Moreover, he thought that a government that was ‘comparatively inactive but does the wrong things’ could do much more to ‘cripple the forces of  a market economy’ than one that is active, but confines itself to measures that assist ‘the spontaneous forces of the economy’.

How should this reasoning be applied today? The Morrisons takeover has come under strong fire from others in the financial sector. Legal and General, the City’s biggest fund manager, cautioned against loading Morrisons with debt and selling off its property assets on the cheap. Andrew Koch, a senior fund manager, feared that this strategy would lead to reduced tax paid to the Exchequer (because debt interest is deducted from profits).

Concerns in the City have been multiplied by the experience of Cobham, the defence group, which was sold to American private equity owners about two years ago. At the time, many warned that the new owners would break up the company, but the Johnson Government authorised the deal after getting some promises. Today, more than half of the business by value has been sold. James Anderson of Baillie Gifford, one of the world’s most successful investors, has recently described the underlying problem as a ‘deep sickness’ in UK capital markets.

The claims of these critics is consistent with the thinking of Adam Smith who warned against misplaced trust in manufacturers, speculators and merchants. They were ‘an order of men, whose interest is never exactly the same with that of the publick, who have generally an interest to deceive and even to oppress the publick, and who accordingly have, upon many occasions, both deceived and oppressed it’.

The Government should not fall into the trap of thinking that it should never intervene in corporate takeovers. There is a public interest in stopping the Morrisons takeover. The company’s model is to own the vast majority of its shops and run some its own manufacturers and farms. It is profitable. Private equity has been granted preferential advantages. Owners are allowed to pay tax as if they make capital gains and not profits subject to higher corporation tax. And owners are able to take advantage of the preferential treatment given to company debt compared with equity. A government that used its powers to encourage Hayek’s ‘spontaneous forces’ would equalise the treatment of debt and equity to preserve responsible private ownership.

If the Morrisons bid is allowed to proceed the owners will probably sell off the shops to another company they control and lease them back, giving them a capital gain and an income stream at the expense of Morrisons. This is wealth extraction not wealth creation. If the Government allows its squeamishness towards intervention to paralyse it into inaction, it will drop helplessly into the trap described by Hayek: that of crippling the spontaneous forces of a market economy by inaction.

David Green: When it comes to economic rejuvenation, there’s no alternative to cutting Corporation Tax

9 Feb

David Green is CEO of Civitas.

With a Budget due on 3 March, the Government has been floating the idea of a windfall tax on ‘excess profits’ made during the Covid crisis. But instead of pondering how to punish companies that adapted successfully to the lockdown, it would be better to ask how we can most effectively accelerate our economic recovery

The case for some resolute tax cutting in the Budget is overwhelming. Excessive taxation can dampen the resolve of the most determined entrepreneurs. Top of the list should be a cut in corporation tax to ten per cent. At 19 per cent the rate is still high compared with several OECD members, and within the EU several countries charge much less. In Hungary it’s only nine per cent, in Bulgaria ten per cent and Ireland’s main rate is 12.5 per cent.

The low rate in Ireland has attracted a long list of international companies with at least a major office in Ireland, and often their European headquarters. Facebook has its European head office in Ireland, as does PayPal, while Google has a major presence. Airbnb has 500 employees, eBay has 900, and Microsoft 2,000. Other big names include LinkedIn, Accenture, HP, Apple, IBM, Pfizer and Pepsi.

It’s true that tax-avoidance shenanigans were heavily implicated in the location decisions of some of these companies, but the low headline rate was the clincher.

What would a cut mean for the public finances? In 1919-20 UK revenue from corporation tax was £63.2bn. If the rate were cut from 19 per cent to tern per cent this figure would be significantly lower, perhaps around £30bn.

However, we can predict a large increase in jobs, which in turn would increase revenue from income tax and national insurance. Both are far more important than corporation tax. In 1919-20 total HMRC revenue was £633.4bn, with income tax producing £193.2bn and national insurance £142.8bn. Revenue from both can be expected to go up sharply. Increased economic activity resulting from the cut in corporation tax would also raise the take from VAT, which brought in £129.9bn in 2019-20. If the revenue from these three taxes increased by only seven per cent it would more than make up for lower receipts from corporation tax.

Cutting the headline rate of corporation tax would also reduce tax avoidance and encourage companies operating primarily in the UK. It is notoriously easy for international companies to shift profits to overseas subsidiaries and pile costs onto their UK branches to reduce taxable profits. It’s much harder for companies whose operations are mainly in the UK to hide their profits, and a cut in the headline rate of corporation tax would be a just reward for their patriotism.

For many years the OECD has tried to reduce the scale of avoidance through its Base Erosion and Profit Shifting (BEPS) project. Member countries invariably give it lip service but little has been achieved. There is a huge literature about the devices deployed to avoid tax via controlled foreign subsidiaries, including strategies based on transfer pricing, the allocation of interest payments, and charges for intellectual property.

The lower the tax on profits, the less it’s worth spending on an army of accountants and lawyers to shift profits without breaking the law. And if international companies engage in fewer tax dodges, the Treasury can spend less on prevention. HMRC now has over 67,000 staff. Some could be transferred to more productive activities.

To make it clear that the aim is to incentivise job creation, the Government could also abolish capital allowances. At present when a company builds a factory or adds a production line it can’t treat the outlay as a cost that can automatically be deducted from taxable profits. Expenditure has to go into a special pool and is deducted from profits over time. It has long been recognised as a perverse incentive against investment, and in 2019 and 2020 the Government increased the capital expenditure that is deductible from £200,000 to £1m. Some want to increase this ‘annual investment allowance’ still further and to add to the list of items covered by the ‘first year allowance’, which is over and above the annual allowance.

But it would be lot simpler just to scrap the whole system and allow all investment in new productive assets to be a deductible cost. Such a dramatic step could easily lead to the multiplication of Nissan-style factories and well-paid jobs throughout the left-behind regions.

Cutting corporation tax would upset the European Commission, which may renew its protests against the evolution of the UK into Singapore-on-Thames. But having learnt nothing from the row over vaccine distribution, it will find itself vainly huffing and puffing again.

The Government is determined to spread prosperity to every corner of the land, but it should not be content with measures like posting civil servants to the North and redistributing infrastructure spending outside the South East. Improving roads, rail, ports and the internet is an essential component of a strategy of economic rejuvenation, but it’s no substitute for cutting corporation tax. Combining the two could be transformative.

David Green: By creating a new investment bank, Sunak would give us a way of using our lockdown savings productively

28 Jan

David Green is CEO of Civitas

The Budget on March 3 should be much more than an occasion for explaining how to pay for the pandemic. The Government should seize the chance to strengthen our property-owning democracy and level-up opportunity through job creation. Equalising infrastructure spending is fine, but it will not re-energise the private sector, which alone can save the day.

The Budget could be a chance to fund a new investment bank that will put money into new productive enterprises without adding to national debt; switch expenditure from consumption to investment; and increase the equity stake of taxpayers in the productive capital of the country.

A similar idea was supported by both Keynes and Hayek at the beginning of the Second World War, the last time we faced vast public debts. In an article in the Spectator in 1939, Hayek made the case for setting up a trust fund that would give the holders of war savings an equity stake in the industrial capital of the country.

Adapting this idea to today’s conditions could be achieved by allowing holders of Treasury bonds to convert them to equity in the proposed bank at par value. With bond yields so low, the possibility of receiving dividends instead of interest might be very attractive.

If 2021 is to be a year of economic recovery, investment spending is likely to create more jobs than consumer spending. Moreover, now that we are out of the EU we urgently need to rebuild the nation’s productive capacity, not least to cope with the rules of origin under the EU deal, which typically require goods to be at least 50 per cent British. To meet the new obligations, some new factories need to be built.

The democratisation of ownership could be further deepened by selling bonds with an interest rate of one per cent, which could be converted to equity after 12 months. With interest rates so low, money would flood in and this would give everyone a chance to benefit from the nation’s success.

There has been an increase in saving during the pandemic, and investing in productive enterprises would be an ideal home for these pent-up savings. The risk of inflation, especially asset inflation, would also be reduced. Quantitative Easing has pumped vast sums into the economy and caused asset inflation. The new bank would attract funds that would add to our productive assets rather than inflating the value of existing assets.

Some will fear that this is a step towards a command economy, but that danger can easily be avoided. Many nations have sovereign wealth funds, usually controlled by their governments. The proposed investment bank would not be a state bank, but a limited-purpose private institution created by act of Parliament

In that sense, it would be no different from a building society or indeed a commercial bank. Both have legal frameworks that limit activity. The investment bank would be prohibited from ‘casino’ activity such as gambling in derivatives or in currency speculation. And if shares are to be sold on the stock market, as they should, it will be necessary to prevent a takeover by anyone hostile to its aims. This could be achieved by a golden share, much favoured in the Thatcher era, or by issuing dual shares of the kind favoured by Google and Facebook to preserve control of their original corporate objectives.

Supporters of a market economy will have their doubts, but this is not a plan for the Government to direct our economic life. It is using the powers of government to build institutions that will empower entrepreneurs, liberate animal spirits, re-vitalise the private sector, and extend our property-owning democracy.

David Green: The new Commission on Unalienable Rights allows us to compare America and Communist China

3 Aug

David Green is CEO of Civitas.

Is it time for a change of policy towards China? As we rethink our strategy, instead of referring to China, we should speak of the Chinese Communist Party (CCP) to remind ourselves that we are dealing with an authoritarian dictatorship. We will constantly misunderstand Chinese rulers if we fail to recognise a simple truth: the ruling party in China is an organisation for keeping power in its own hands. It is as much in conflict with the Chinese people as with foreigners, as the experience of Hong Kong has reminded us.

The party doesn’t even have the excuse of believing that its high ideals justify violent methods. Everything is an instrument for keeping power. If voicing highfalutin ideals helps, then they will be proclaimed. If ideals widely shared in human history are obstacles, such as universal values and an autonomous civil society, then they will be denounced. Power is everything.

In the West, we are reluctant to think that a regime could be quite that bad. There is good in all of us and we never stop looking for it. But the internal documents of the CCP repeatedly give the game away. Take one prime example, the infamous Document Number Nine, distributed to party leaders in 2012 soon after Xi Jinping came to power. It was leaked the following year and we know that the person responsible was jailed for seven years for revealing state secrets. They didn’t want us to know about it. A translation is freely available on the website of the online publication, ChinaFile.

The document highlights seven false ideological trends found among the Chinese people. The first is promoting Western constitutional democracy, whose dubious characteristics include the separation of powers, the multi-party system, general elections, and an independent judiciary. The goal of Chinese enthusiasts for Western constitutional democracy is seen as undermining the CCP’s leadership and abolishing the People’s Democracy.

The second target is the promotion of universal values. Chinese people who champion them aim to “weaken the theoretical foundations of the Party’s leadership” and supplant the core values of socialism.

The third ideological tenet is “promoting civil society in an attempt to dismantle the ruling party’s social foundation”. This dubious doctrine holds that individual rights are paramount and that they “ought to be immune to obstruction by the state”. But advocates of civil society want to “squeeze the party out of leadership of the masses at the local level”. The fourth target is the neoliberal market economy, which aims to “weaken the government’s control of the national economy”.

The fifth target is promoting the West’s idea of journalism, which challenges “China’s principle that the media and publishing system should be subject to party discipline”. The ultimate goal of advocating Western-style journalism “is to hawk the principle of abstract and absolute freedom of press, oppose the party’s leadership in the media, and gouge an opening through which to infiltrate our ideology”.

Sixth is promoting “historical nihilism” or questioning the CCP’s interpretation of the past. The aim is “to fundamentally undermine the CCP’s historical purpose, which is tantamount to denying the legitimacy of the CCP’s long-term political dominance”.

Finally there is questioning reform and “the socialist nature of socialism with Chinese characteristics”. If these ideas are allowed to spread, “they will disturb people’s existing consensus on important issues”. Within China’s borders, some private organisations were creating “reactionary underground publications”, filming documentaries on “sensitive subject matter”, and “defaming the party and the national leadership”.

The seven ideological trends must be resisted by strengthening “leadership in the ideological sphere” and forcefully resisting “influential and harmful false tides of thoughts”. The party must not permit “the dissemination of opinions that oppose the party’s theory or political line”. There must be “unwavering adherence to the principle of the party’s control of media”. We must persist in “correct guidance of public opinion, insisting that the correct political orientation suffuse every domain and process in political engagement, form, substance, and technology”.

Finally, the party must reinforce our management of “all types and levels of propaganda” and “allow absolutely no opportunity or outlets for incorrect thinking or viewpoints to spread”. The party must “strengthen guidance of public opinion on the Internet” and “purify the environment of public opinion on the Internet”.

If the document had aimed to define totalitarianism as succinctly as possible, it could hardly have done a better job. As it happens the US State Department has just published the report of the Commission on Unalienable Rights, which allows us to compare America and Communist China.

There are plenty of Americans who criticise their own country, most notably for failure in race relations, and there are some who detect a whiff of unbridled power seeking in President Trump’s proposal to delay the November election. He was, however, overruled by Congress within a few hours (whereas no one in China can overrule the supreme leader).

The report of the Commission on Unalienable Rights is a nuanced defence of a free society, which steadfastly defends its own values without arrogance or righteousness. The preface begins with an acknowledgement of America’s faults. With recent racial divisions in mind, it says:

“With the eyes of the world upon her, America must show the same honest self-examination and efforts at improvement that she expects of others. America’s dedication to unalienable rights – the rights all human beings share – demands no less.”

The report reaffirms America’s commitment to the Universal Declaration of Human Rights (UDHR) because it reflects America’s founding values. Perhaps with China in mind, the report asserts that there can be no moral equivalence between “rights-respecting countries that fall short in progress toward their ideals” and countries that “regularly and massively trample on their citizens’ human rights”.

Maybe the sharpest contrast with Document Number Nine is found in the declaration that “in a free society, the laws will leave a vast range of human activity to the conscience of each” and in its reminder that the US Constitution protects freedom of speech “by declining to give Congress the power to pass laws prescribing or proscribing beliefs, utterances, and publications”.

The report urges the American Government to defend human rights with renewed vigour, with pride in what has been accomplished, combined with humility born of the awareness of her own “shortcomings and imperfections”. But, it proclaims that in the war of ideas between liberal democracy and autocracy, “the uneven progress of liberal democracies does not invalidate the lofty goals to which they are dedicated”.

About the same time as Document Number Nine was being sent to Communist leaders, our own David Cameron and George Osborne were declaring a “golden era” in relations with China. Looking back we can perhaps see that this was one of the biggest foreign-policy blunders of recent times.