“There are certain things that cannot be adequately explained to a virgin by either words or pictures. Nor can any description I might offer here even approximate what it feels like to lose a real chunk of money you used to own.”
– Fred Schwed, US Investor
“The only difference between the taxman and a taxidermist is the taxidermist leaves the skin.”
– Top rate taxpayer, 1974
Unless you don’t read newspapers anymore and have stopped watching “Bad Noise at Ten”, you’ll have noticed a growing demand from “talking heads” to the Chancellor of the Exchequer in the Budget next month, or indeed for “the next Labour Government”, to raise taxes and “soak the rich”. Thus we’re told that all the problems of millennials, inequality and something called a fiscal deficit will be solved at a stroke.
The move to “soak the rich” has already begun. Take the move to thump those nasty non-doms. Whatever the rights and wrongs of their tax status they contribute more to the UK economy than is generally reported. In income taxes alone they chip in a very reasonable £10 billion a year, which according to underemployed number crunchers is equivalent to 2p on the basic rate of income tax. There’s an estimated 120,000 of them, most of whom are rich in anybody’s language, and you can only imagine how much extra boost they give to the UK economy with all their spending and investment.
But already it looks like many of them have had enough. They have been long-term buyers at the top end of the UK property market. But since George Osborne’s hike of Stamp Duty three years ago, turnover has fallen by 40% plus. Buyers have become sellers. And those selling are leaving the country. It may be a surprise to tax-raising theorists but not to me or you. Wealth moves. And then you end up with nothing. It’s an extreme example of what’s called “the Laffer curve” (though it doesn’t sound funny to me). Next up, apparently the fresh targets are our businesses, the asset rich and high earners.
The tax drum is still being banged by theorists deaf and blind to reality. Yet out of 26 global studies over the last 35 years comparing tax rises with subsequent economic growth, 90% show a negative impact of higher taxes on GDP. The worst damage they say comes from higher corporate taxes followed closely by higher income taxes. Independent analysis reckons for every tax increase equal to 1% of GDP, real GDP reduces by 2% to 3% per annum. Oh dear.
But I wonder how many of us actually experienced the pains of high taxation and double-digit inflation in the UK back in the 1970s. And how many remember the economic mess the country ended up in for years afterwards.
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Sure, you can Google it nowadays and read about it to your heart’s content. But as Fred reminds us above, unless you lived through that debacle and earned enough to suffer the slings and arrows of outrageous taxation and inflation you can’t imagine how it felt.
Despite what Fred the Schwed said, let me paint the picture of what it was like for successful small businesses and investors back in the 1970s when a previous Government decided to “soak the rich” to “cure inequality”. And then let’s look at some investing tactics that worked previously in protecting your wealth during high taxes and rising inflation and the resultant downward pressure on the pound.
A past imperfect
When I was at university in the late 1960s I knew nothing about tax or interest rates. None of us ever talked about such things. Few of us came from wealthy or middle class backgrounds, so most of us qualified for tax free grants, thank goodness.
When it came to finding a job in the real world I faced a dilemma. I graduated with an Honours degree in Geography with Maths as a second subject, but I didn’t fancy teaching or cartography. What to do? Somebody said that actuaries earned tons of dosh for sitting on their backsides cuddling log tables, guessing future gilt yields and eating for free in corporate dining rooms. It sounded perfect. So I convinced Scottish Widows I was the missing link. I started as a trainee actuary in 1969, just in time to catch basic income tax rates at 38.75%.
As a working class boy it was my first foray into the world of money. Over the next four years I learned about pensions, endowments, annuities and the early stages of unit linking. By 1973 I’d had enough of the “fun” of Insurance Company life. I became an Independent Financial Advisor in January 1973 just in time for wholesale changes to the UK’s tax and pension regimes, not to mention the October stock market crash nine months later. Pure coincidence!
For those badgering the Chancellor of the Exchequer today to increase taxes on us “oldies” in order that the “young” can be taxed less, let me remind you that basic rate tax in 1973 was still 30% and climbed to 35% two years later. Currently it’s only 20% for all ages. We paid our way. Go check.
And let’s not forget that the top rate of income tax on salary/wages by 1975/76 was an eye-watering 83%. And if by some miracle you had accumulated investment income (like dividends or bank/building society interest) on top you could pay tax at 98% on the margin. If you think that was bad enough, the UK inflation rate over those 12 months was 26%.
In the 1960s there was a “super tax” top rate of 95%, which inspired The Beatles to write this in 1966:
Let me tell you how it will be, there’s one for you, nineteen for me
Cos I’m the taxman, yeah, I’m the taxman
Should five per cent appear too small, be thankful I don’t take it all
Cos I’m the taxman, yeah I’m the taxman
For those of you allergic to percentages, for every £1,000 earned on the margins for high earners and successful savers you could be left with a mere £20. And your cost of living rose by over a quarter. Yet commentators get their knickers in a twist now about a possible three per cent inflation rate and a bank base rate increase from 0.25% to 0.5%. Are they serious?
Being young and poverty stricken I didn’t suffer from high taxes personally but I saw the effect on my clients. In 1975 I advised two partners in a successful business. They were so successful their taxable joint profit over the following year was £100,000, split 50/50. Dave was single. Ron was married. Each paid £37,000 in income tax! It got even worse. Both saved regularly into deposits. At the time, top deposit rates were 10% before tax. They assumed they paid basic rate tax of 35% on interest earned. Yikes.
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Their individual tax computations which they’d filed away without studying showed the true picture. Dave paid 98% tax on the margin. Ron, having the advantage of married man’s allowance, was only taxed at 93%. It’s not hard to imagine how Dave felt when he realised that he earned in theory 0.2% after tax on his interest, but in practice including inflation he’d actually lost 25.8% – in a year. Ouch.
Further bad news for the “rich” was the introduction in 1975 of Capital Transfer Tax. Under this new tax, lifetime or on-death transfers accumulating to above £15,000 were subject to tax up to 75%. Not content with such penal tax rates the then government thought of introducing a Wealth Tax of 1% per annum in 1974. Fortunately it didn’t happen but I see Mr Corbyn is said to be planning to put that right when he gets the chance.
So was it only the “rich” who suffered high taxes? Sadly not. At the time, ordinary savers were penalised too. My dad was a bricklayer working long hours as a basic rate taxpayer. My mum worked in a local law practice. She was a saver as many in that generation were. She saved all her net income in a Building Society account. But because a wife’s unearned income was taxed as the husband’s until 1990, he paid 50% tax on her BS interest. Yes, really! So be aware. Tax rises will hit more folks than you’d imagine.
So what can you do to minimise the impact of higher taxes?
Well the obvious thing to do if you’ve enough wealth and income is you’re still free to leave the country. The uber-wealthy may choose Monaco, Switzerland or the Channel Islands. For the rest of us maybe Portugal’s a decent bet these days. Ten years tax free, I hear, with sunshine and golf thrown in. The Scots may be attracted to the Isle of Man: low income taxes, no capital taxation alive or dead. OK, it rains there. But it’s just like home with less tax and more windy days. No midges then. Sounds idyllic.
But for most of us who prefer to stay put there’s still action to take that will probably shelter you until the proverbial hits the fan and tax rates fall again. As they will. Eventually.
Remember what Professor Cecil Northcote Parkinson said about tax: the UK tax system is designed to tax income when you’re living and capital when you die. So it’s a worthwhile idea to reverse them: create capital when you’re around and leave income when you pop your clogs. He said that all of 50 years ago and while much has changed, the principle still works.
For those of you who still think Pension plans are a busted flush you are missing a trick. You can shelter high-taxed income in a plan protected by a simple trust, rolling up free of capital gains tax, and well able to provide tax free or low tax income or lump sums whether you’re alive or otherwise. And you’re free to choose international funds inside your plan to protect against any run on sterling. This is an increasingly complex area. Go see a specialist and get advice now.
And there are opportunities to shelter savings for husbands and wives and those in civil partnerships nowadays that weren’t available years ago. They can choose how to receive unearned income, and split taxable gains so as to pay less tax or even reduce to zero. I understand that capital gains annual exemptions are still significantly under-utilised – it’s madness – as are opportunities to swap chargeable assets between each other to save tax. I still meet couples where one pays no tax, the other pays at 45% and unearned income is received by the taxpayer. Arrgghh!
ISAs are especially effective now, and no doubt will be even more useful in a higher tax regime. Goodness knows why savers don’t fill their boots with them. That’s non-Cash ISAs, naturally. There’s no personal income tax on unlimited “income” taken, and no Capital Gains Tax whatever. And when your spouse or civil partner dies, their portfolio can be transferred to you to enjoy continued tax freedom – a no-brainer.
Of course, similar tax freedoms exist with investments in Venture Capital Trusts, Enterprise Investment Schemes and the like, with an added benefit of tax relief. But it’s the long-term benefit of tax-free income for life and beyond that appeals to me – and to clients.
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Then there’s the long forgotten and often misunderstood tax plan par excellence if you’ve used up the various opportunities spelled out above: the Investment Bond, Onshore and Offshore.
Like private pension plans these tax effective “vehicles” came under criticism for high costs, especially in the bad old days of commission. Personal finance journalists took great delight knocking these lump sum investment plans writing about the rip-off costs associated with them, or complaining of their crap returns in the halcyon days of With Profit Bonds.
But as I often pointed out, costs or commission levels were not obligatory, and you could easily hold good investment funds inside the structure. As they say, GIGO – garbage in garbage out!
What’s the tax advantage? In times of high taxation you can invest unlimited chunks of capital in these bonds, roll up your gains/profits free from high taxation, draw an “income” without incurring income tax, and encash effectively once tax rates fall again. They were a very effective shelter from the high taxes in the 1970s until rates declined a few years back, and could be a secret weapon for long-term asset-rich investors again. But do watch. There’s no need to be ripped off.
Variations can be useful for UK residents intending eventually to live abroad, and especially so for those wishing to gift assets to younger generations who wish to avoid increased tax on Trusts.
Finally, let me offer some romantic tax planning advice to those co-habiting: get hitched or end up being stitched. HMRC loves you baby.
And for all readers, go take advice. And don’t hang about.