The News is filling up with two words – almost on a daily basis – ‘Private Equity’. Today, for example, we hear that the AA and SAGA both are owned by Private Equity and yet no one listening to the news, or at least very few have much idea what that phrase means, or why that matters.
Surely Private Equity means that the owner owns the business, and that they are either private individuals or not publicly quoted companies that own the shares. So why does that matter?
It matters not a jot except for one fact – that these individuals or private companies that buy the business like AA and SAGA, do it with borrowed money, and offset the borrowing costs against the trading profits of the businesses they run. So that they pay no corporation tax, and the government loses billions.
It’s like someone buying a house on a 100% mortgage, renting out the property to a tenant who pays rent which clears the mortgage for you. The first result is that they pay no income tax, as their income is eliminated by borrowing costs. Property prices rise. The owner makes money, but the government loses out.
Why though would anyone want a business that makes no profit?
That’s easy to explain. You pay no income tax, or corporation tax, and look forward to making a capital gain. If an investor makes profits inside a company, and they decide to take money from the profits earned out of that company for their own personal use, since 1997 when Gordon Brown changed the rules on National Insurance, these individuals are paying 64% (income tax at 40% plus national insurance at 24% – employee’s which is visible and employer’s which is hidden). The result has been that very few people who are in business to make money, are going to bother paying themselves salaries like that or receiving dividends which are taxed at a similar rate.
Pre-1997 directors could get money out of their businesses and pay 40% as National Insurance didn’t apply. To receive £60,000, they needed to take out £100,000 from the company (income tax at 40%). The whole £100,000 was offset against corporation tax at 30% so the government recieved 10% net. After Gordon Brown’s changes, you needed £160,000 to pay £60,000. The offset against corporation was worth £48,000 (30% of 160,000), so instead of it costing net £10,000 in tax to pay out £60,000, it now cost £50,000. That is why investors looked for other ways to avoid paying national insurance on business profits.
National Insurance before Gordon Brown was not a tax. It was the way each individual paid into the national pension system so that they earned the entitlement to draw out later on. The sums in and out bore a relationship to each other that was not brilliant but was fair. There was always a surplus each year of more paid in than paid out, and rather than pay people better pensions, governments of all hues began to use this to fund general expenditure. Gordon Brown was stealthy and he uncapped National Insurance so that it was payable on all income and not just up to the ceiling which was about £30,000 per annum.
The result has been not the huge increase in tax take Gordon Brown expected. The opposite has happened. Why?
The other change Gordon Brown made in his early years was to reduce Capital Gains Tax so that people who bought businesses and sold them making a capital gain, needed to pay only pay 10% of their gain. This was Goron Brown’s idea to promote enterprise and keep the City pumping money into the British economy and keep it growing. It has led to huge growth in investment as you would expect, helping to fill Gordon’s coffers.
But the result of the two totally different approaches to taxing business – one giving owners who buy and sell companies an almost tax free environment on their capital gains (losses can be offset and these can be acquired by selling assets at a loss amongst ‘friends’) – the other taxing people at extortionate levels, who actually work hard and try to make profits longterm inside companies. It has seriously unbalanced the relationship between capital and labour. It has also lost the government billions of pounds in revenue.
It is not worth people’s while to run companies and keep them longterm and buld them up over a lifetime. With the tax system as it is, it is only worth manipulating for quick capital gains. Businesses like the AA that have built up a record of longterm trust with millions of customers by taking only a reasonable charge from them for a good service are easy pickings for a quick increase in capital value.
Private equity buys a business like the AA which was running a longterm startegy of building trust with clients, cuts its oveheads by reducing staff, increases its prices and pushes out into other businesses to maximise revenues, all on borrowed money. Then the business is sold to shareholders attracted by the rising returns, and the private equity people, who borrowed everything, sell out making a huge capital gain which attracts a maximum of 10% capital gains tax. The government loses billions in corporation tax, and the amount of debt in the economy heads ever skyward exposing the whole economy to higher risk.
Gordon Brown seems to love tinkering with all the little details and he has made the tax system blindingly complicated. But this aspect is simple. Don’t bother working inside companies and trying to produce income. Borow all you can, make capital gains. That goes for the biggest corporations to every individual. Is it any wonder that Britain’s economic peformance is slipping? And is it any wonder that Brown’s tax take is not enough from the economy we do have? Also the economy will be far more vulnerable to a credit crunch – and rising interest rates will hurt government revenues far more than they used to do.
Gordon Brown’s supposed to be some kind of economic genius. The evidence for that needs finding. The news channels don’t explain what private equity is, because they would have to tell people the true story about Gordon Brown. That would never happen in the media world we live in today where governments control news and reporting tightly. That’s why you need to read blogs to find out the simple facts. Private Equity is caused by stupid tax laws. Who made those laws? None other than Gordon Brown.