Hail to the Tax Cuts

Story Outline

• Political turmoil is brewing in Britain over allegedly delayed elections and proposed major changes to the British tax code.
• The proposed changes are a mixed bag. A simpler tax code would be a positive, but some other proposed changes could be negatives.
• We see nothing disturbing about the postponed elections. However, it's too early to determine what, if any, tax changes Britain will implement.

Pretend Hillary Clinton is president. (If that makes you deliriously happy or blindly nauseous—get over it. Political biases lead to major investing errors.) Anyway, President Clinton (stop it) is very popular in our pretend world, enjoying a double digit poll lead. An election looms, and it's likely her party will win extra seats—ensuring easy passage for her agenda.

Now, suppose Karl Rove (he's still around) gets his buddy, Senator Giuliani, to support an aggressive tax cutting plan with a stirring speech. Overnight, a groundswell of popular support for the Rove-Giuliani plan makes Rudy and Hillary poll dead-even—and momentum is building.

In our pretend world, Hillary doesn't necessarily have to hold the impending election—so she declines, pushing back a potential power swap for a couple years. But she hates losing popular support, so she adopts the Rove-Giuliani tax-cutting and presents it as her own. Sound ridiculous? Perhaps—but it's pretty much what's been transpiring over the last week in the UK.

Most Brits were expecting Prime Minister Brown (Labour Party leader—think Democrat) to call for November elections. But he punted after a Conservative (i.e., Republican) proposal to raise the hated inheritance tax threshold proved hugely popular—shifting polls dramatically. Read about the proposal and the dust-up here:

Tories Would Cut Inheritance Tax
the Staff, BBC News

So what did PM Brown do? He presented his own plan, eerily similar to the Tories. The highlights include the higher threshold on the inheritance tax—essentially doubling the amount families can pass estate-tax free—and a flat capital gains tax. New taxes include a £30,000 per year charge on those claiming "non-domicile" status after seven years. ("Non-domiciles" are folks living in the UK but claiming residence in other nations. Previously, they were charged UK income taxes only on income remitted to the UK—an attractive incentive for wealthy foreigners living in the UK.)

This is massive news in Britain, where House of Commons sessions resemble nothing so much as a rowdy rugby match. The liberal end of the Labour party complains there's no way to "pay" for these tax cuts. (Silly politicians! Haven't they heard of the Laffer Curve?) The other end of the spectrum complains the scheme unfairly penalizes small business owners and the new inheritance tax threshold isn't nearly high enough and still punishes middle-incomers. Further, they claim PM Brown is pulling a fast one by not holding the "promised" elections.

Our reaction? Tempest in a teapot. (Brits love tea!)

First, the tax cuts are a mixed bag. If implemented, tax rates overall on equity investments will be simplified and much cheaper. But tax rates on private investments will rise—which could be a negative for small businesses. Raising the inheritance tax threshold is great. (Eliminating it would be even better.) But the non-domicile tax might be a negative if wealthy Brits stop pretending to live in other nations and actually pull up stakes and move.

Further, the budget isn't finalized until April—giving politicians plenty of time to do dumb things like reject the cheaper tax rate. Or—our favorite—"paying" for tax cuts by raising taxes elsewhere. (The whole idea of "paying" for tax cuts with tax hikes is a bit like robbing Peter to punch Paul in the face—but we digress.) And, the delay also gives the market plenty of time to price in any proposed tax changes.

As for the political melee—there's no way to know this—but possibly Gordon Brown never intended to call an election. This is a guy who waited ten years for his shot at 10 Downing. It's hard to believe he'd risk it all just four months later by calling an election. He may be British, but he's still a politician—his chief concern is holding onto power with both hands.

Maybe wavering on the election was a political ploy to energize his Labour base while forcing Tories to show their hand. Once he knew their plans, he could either discredit them or just implement them himself! Of course, he couldn't know the Tory inheritance tax plan would prove so popular. Delaying elections after such a popularity switch would look pretty darn fishy. With a public clamoring for tax reform, and a PM unwilling to lose his office, what choice did he have but stealing their playbook?

There's too much time between now and April to handicap what the Brits are likely to do. We'd like to see a shift toward lower and simpler taxation in Britain. Come to think of it, we'd like lower, simpler taxation here! Britain's recent stock rally isn't instructive about what we can expect over the next few months—too much uncertainty remains. For now, we'll just have to wait and see.