Liberal Democrat financial manifesto analysis

Posted on: 28 April 2010 by Mark O'haire

Vince Cable has stood out as a voice of reason throughout the financial crisis but how do his figures stack up and how will the Liberal Democrats balance the books if elected?

It was recently put to me that if you had experienced two workmen at your house who hadn't completed a good job, had promised you lots, and broken those promises, you might consider it was time for a quote from another builder. It would also be interesting to consider what might happen if those same builders were then allowed to quote.

If both the two previous builders gave you no detail in their new quote but the new builder gave you a clear breakdown of all the painful bits, the decision would be pretty straightforward.

That's how the election seems to be panning out and we might consider the plight of the Liberal Democrats and their challenge of overcoming the voter's syndrome of 'but still we know both these builders, no matter how bad or good they may be'.

There is considerable apathy in the public. Consider how MPs and banks have really got off scot free. Banks for example are responsible for 79.15% of all complaints upheld by the Ombudsman, an astonishing statistic which is less astonishing than the statistic that people still use banks.

Sometimes we all get caught gazing at our shoes whilst we walk through our life. Now and then a look up is a good idea to avoid the pain of a ninja lamp-post.

Lib Dems Manifesto

Unlike the red and blue team, the Lib Dems have opened themselves up for scrutiny for their financial numbers and that's where I might take an opportunity to have a whack at them.

In 2003, I wrote my first column regarding the overheated housing market and that we were relying on this as a fantasy bank account - a sort of ATM.

Interestingly, in the House of Commons in 2003, Vince Cable (Lib Dem) put a question to Gordon Brown that "the growth of the British economy is sustained by consumer spending pinned against record levels of personal debt, which is secured, if at all, against house prices the Bank of England describes as well above equilibrium level?"

In a reply that will haunt him, the man in charge of money at the time replied: "The honourable gentleman has been writing articles in the newspapers, as reflected in his contribution, that spread alarm, without substance, about the state of the economy..."

For five years I repeated how that bubble was unsustainable but the government and the Bank of England continued to allow it to happen. The recovery may not be a double-dip but I'm confident that the 'square root symbol' recovery could have been avoided with a more careful management of our finances.

We were encouraged to spend and use our houses like an ATM whilst the government were doing the same. It's perhaps more alarming that Gordon Brown announced that he was told by the banks they don't want to be regulated and felt they were being over regulated.

What a laugh that is. The outcome of that decision has set us back years. If we had gold we could have sold it to save us but unfortunately Mr Brown also sold the reserves, costing us nearly $12bn against current prices.

The Lib Dems are the only real manifesto to face up to it. We'll be facing a very tough time over the next few years. Remember we're still struggling along even though we have rates at their lowest level in history. The Lib Dems are saying they are, "committed to setting out the tough choices we are prepared to take, so that we can balance the country’s books."

If you look at their manifesto they appear to be doing that.

Let's look at their plans.

The Lib Dems want to break up banks and get them lending again.

They want to introduce a banking levy so that banks pay for the financial support they have already received and they want to set a £400 pay rise cap for all public sector workers.

The objective of the latter means the gap between the higher earners and lower earners will reduce. They also intend to restore the link between basic state pension and earnings although that could prove much more expensive for them, than they think as they've agreed a 2.5% minimum. That will be catastrophic in a deflationary environment and is a promise I wouldn't make.

Interestingly, other plans are to cut the Department of Health by half and reform payments to GP's. There looks to be quite a bit of spending on education, with the scrapping of university tuition fees during first degrees, and the cutting of class sizes to ensure children get individual attention.

It might be worth them studying the third institute of maths and science studies which highlights the superior education results enjoyed for some time by Singapore, Korea, China, Japan and Hong Kong. Class sizes there are greater than in the UK and 'culture towards education' after school hours is deemed responsible for the results children receive.

Indeed whilst Labour are under-fire for public spending, it's worth noting that England has the largest improvement in score since 1995 for mathematics and is in the top ten for science results. In an interesting move, the Lib Dems want to give schools greater freedom to make the right choices and are investing £2.5bn to help struggling kids.

Unlike the red and blue team, the Lib Dems have opened themselves up for scrutiny for their numbers and that's where I might take an opportunity to have a whack at them.

I suspect it's because of the state of the economy, the red and blue teams didn't publicise their inevitably horrible numbers, so it seems a little unfair to have a swipe at the gold team but hey ho.

The Lib Dems want to raise the threshold at which we pay tax to £10,000, free 3.6 million pensioners and earners from tax completely, restrict tax credits, introduce a 'mansion' tax for properties over £2m, give tax relief only at basic relief for pensions rather than at the higher rate, tax capital gains at the same rates of income, reform local taxation including looking at scrapping council tax, and also replace the air passenger duty with a per plane duty.

They have also stated they will reform the system of non-domiciled status allowing people to hold that tax status for up to seven years after which they will be subject to tax on all offshore income in the same way as if they were domiciled here.

They state they have 'already identified £15bn a year in government spending they can save. They have said this saving will be used for all additional spending with any other savings going to reduce the deficit.

Their view is that the economy should be in a stable enough condition to bear the brunt of changes by 2011, commenting that if it's too early it would undermine the much needed recovery - at last someone who has spotted the implications of this.

The Lib Dems have announced they will end payments to child trust funds which has been a disaster.

They have announced they will scale back home-buy schemes which have been very popular for first time buyers.

They will also announce a full scale review of value for money in the public sector finances and as part of a comprehensive spending review will establish a council on Financial stability involving representatives from all parties, the governor of the bank of England and the chair of the FSA - the same people who were in power whilst we meandered into this mess we are in.

The detail does not include any mention of engagement with businesses in the private sector - the ones that pay the taxes.

Page 96 does list all the key important information on income and expenditure but the roundness of the figures is enough to question their accuracy which I will cover later.

Some of the environmental policies appear to at least have thought through how to get people thinking about greenness. There are plans to invest £400 in refurbishing shipyards so they can manufacture offshore wind turbines and setting clear targets so that 40% of electricity comes from renewable resources by 2020.

The one year Eco cash back scheme will also be seen to be focusing the general public on the real issues in relation to efficiency and wastage.

As far as businesses are concerned, the Lib Dems have announced a few key measures. They are committed to allowing small businesses to be taxed on cash flow, cut red tape, reform the unpopular business rates so they reflect site values rather than rental and overhaul competition powers.

I hear it over and over but they dont do it and the Lib dems have echoed it -  taxpayers' representatives on boards of banks that the public own or part own should insist banks lend to viable businesses on fair terms again'.

Nice story, I'll not hold my breath. Currently there is absolutely no pressure on these banks to do this despite all the talk.

An exciting move however is to support the establishment of local enterprise funds and regional stock exchanges which will help local investors put money into local businesses where they are, as well the regional stock exchange allowing businesses access to equity without having all the regulatory requirements of a London listing.

Summary of Lib Dem proposals

There is no doubt in my mind whatsoever there are large savings to be made from public sector spending. The mindset is not private sector where every expense needs to be carefully considered and come what may, profit is the only target which is what drives their efficiency. But every decision has its consequence.

The move to align capital gains tax to income is ill thought through. What impact will that have on public confidence due to the pressure this will place on demand for property. This is double taxation of the highest quality.

Investors will also now suffer a  double whammy as they have moved from the less tax efficient investment bonds (taxed as income) only to be told they will now be subject to a battering for all their gains under a new capital gains regime.

Many of these investors will have incurred exit penalties on the previous plan, ingoing fees on another plan whilst now being battered with capital gains tax which will be added to their top rate of tax.

Some investors have bought a home for an extra income which is subject to income tax to now be walloped by a tax at the very highest level on any gain at sale.

You just cannot play with people's lives like this.

People use the rules provided by the government to plan and then the rules are changed. If the Liberals are to win over votes they will need to ensure that the gains are measured from the day they take over or drop the plan completley.

Consider a person who bought a house twenty years ago and has rented it out and paid all the relevant income tax on the rent.

They may have paid £30,000 for a house that's worth £150,000 now. The £120,000 would be added to their income for the year and taxed at the top rate. So for all the risk in owning that property they may pay nearly £60,000 in tax.

What's the point? Furthermore this would have a large dampening impact on house prices.

Why would you hold investments like this when the tax makes it a pointless exercise.

And so with falling demand in a market that is already oversupplied, house prices will get smashed.

The inevitable is the fall in confidence as the Uk is a debt driven economy and people borrow and spend based on the gap between their perceived value and what they owe.

If this is diluted, the impact on spending and in turn GDP will be immense.

Capital gains tax used to be added to the top slice of income but there were a whole range of fair allowances in place that allowed for the gain to be discounted based on how long it was owned for example.

The system was fair and encouraged investment. This change is unreasonable and would be a definite reason for me to not vote for them and given that they were leading up to that point it looks like I won't be voting again.

As for the first £10,000 being free of income tax and that helping those on lower incomes. Hmmm. The IFS confirm that the poorest fifth of households do not earn enough to pay tax. In any one year, 33% of adults dont pay tax and 25% of adults live in a family where no-one pays tax. It will not benefit them at all. As you might suspect, much of this is aimed at the higher earners as if they are evil for their success. If you tax brains, the brains will simply leave.

The reduction in tax relief on pensions is a clever one. For the most part people simply pay their pension contribution but dont really care too much beyond that.

The extra tax relief will be an easy target as it will be seen as a perk that has been take away. Moreover the person who then decides not to contribute will be caught even worse as their taxable income will increase and so instead of receiving 30% relief at the highest rate they will be taxed in full at 50%.

Taxing houses worth more than £2m is one thing, calling them mansions is another and fits in with the wrong attitude toward wealth.

Attacking people's pocket because they are successful gives the wrong impression to would be entrepreneurs and if we understand the Pareto principle, 80% of results come from 20% of what we do, you will know that principle applies to tax payers. If we disenfranchise that 20% of people creating the wealth, the outcome is not pretty.

The Lib Dems also confirm they can create £4.6bn by anti avoidance tax measures which seems a remarkably detailed figure and one which the current governments clearly have been slack on. Devil again is in the detail of that which of course we don't have.

The calculations in relation to tax all seem pretty fair but the anti-avoidance measures are unclear. Also the calculations around how most tax payers will see their income tax bill reduced by £700 a year will be in question. One fifth of us dont pay tax so there is no change there, pensioners income tax allowance is near £10,000 now, so no change there, so we can only assume that the middle pay less tax and the top are absolutely battered if they are expected to raise £17bn.

Remember two important issues here: If they do raise that money via all the planned measures, the extra costs will be added to the person using the services (for eg the extra £3bn tax expected to be raised from switching to a per plane duty rather than a per passenger duty).

The flaw in this plan is also around the differentiation between aircraft. Airsouthwest fly a dash 8 aircraft from London city to Cornwall for the same fuel as a 747 uses to taxi to the end of the runway. Let's be clear, specific and targeted about what we are trying to achieve here.

So high earners pay lots, lowest earners don't see a change and there is lots of a lack of detail as to who the middle group are that benefit from some unanswered numbers.

They could have blown it with that so a hung parliament it is then.

6/10 It could have been 7.5 but the capital gains tax plans and income tax proposals are flawed.

By Peter McGahan

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Peter McGahanPeter McGahan is an Independent Financial Adviser and Managing Director of Worldwide Financial Planning. Worldwide has won 16 Financial Times awards in the last four years. Peter has also been named the top media IFA of the year by in 2009.

Peter comments regularly in major journals such as the Mail on Sunday, Irish News and Sunday Times and is a weekly columnist for FT Adviser. He has also appeared on Working Lunch and the Today programme. In addition he is an expert on international tax matters for a range of international publications.

Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'

Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made. The above represents the personal opinions of Peter McGahan. All information is based on understanding of current tax practices, which are subject to change. The value of shares and investments can go down as well as up.

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