§ I now turn to the taxation of saving.
§ The sharp decline in the ratio of personal saving to personal income, over the past two years in particular, has led to even more discussion than usual of the merits of providing greater tax incentives for personal saving.
§ Certainly it is desirable that, over the medium term, we generate as a nation a level of saving sufficient to finance a high level of investment, but what matters for that is not personal saving alone, but corporate saving too, which is running at a historically high level, and public sector saving, which has been boosted by the move to budget surplus.
§ Moreover, the personal saving ratio is measured in terms of gross saving net of borrowing, and it has fallen not because of a decline in gross saving but as a result of the sharp increase in personal borrowing. The appropriate remedy for that is to raise the cost of borrowing, and with it the return on savings, as we have done.
§ Above all, the role of tax reform is to encourage enterprise and improve economic performance in the medium term. It is wholly inappropriate as a response to short-term or cyclical phenomena. So for the taxation of savings, the Government's policy is clear: it is to strengthen and deepen popular capitalism in Britain, by encouraging, in particular, wider share ownership. I have a number of specific tax measures to announce today to that end.
§ Personal equity plans, or PEPs, were first announced in my 1986 Budget, and started up in January 1987. As the House knows, those who invest in these plans pay no further tax at all, either on the dividends they receive or on any capital gains they may make—indeed, there is no need for them to get involved with the Inland Revenue at all.
§ Personal equity plans got off to a good start, with over a quarter of a million investors, many of whom had never owned shares before, subscribing almost £500 million between them in 1987.
§ Since then, however, the take-up of new PEPs has slowed down, not least as a result of the changed climate in the equity market which followed the October 1987 stock exchange crash. So the time has come to improve and simplify PEPs and give them a new boost.
§ First, I propose to raise the annual limit on the overall amount that can be invested in a PEP from £3,000 to £4,800. Secondly, within that, I propose to raise substantially the amount that can be invested in unit trusts or investment trusts. For many small savers, these provide an excellent introduction to shareholding.
§ At present, PEP investors are limited to £540 a year, or a quarter of their PEP, whichever is the greater, in unit or investment trusts. I propose to increase this limit very substantially, to £2,400 a year; and the whole of a PEP will be able to be invested in unit or investment trusts, up to 301 this limit. To qualify for tax relief, the unit or investment trusts will be required to invest wholly or mainly in United Kingdom equities.
§ Thirdly, at present, only cash may be paid into a PEP. I propose that investors should also be permitted to place directly into a PEP shares obtained by subscribing to new equity issues, including privatisation issues.
§ Finally, I propose to make a number of important simplifications to the PEP rules so as to make the scheme more flexible, better directed to the needs of small and new investors, and, above all, cheaper to administer.
§ I am confident that the changes that I have announced today will enable personal equity plans to play an important part in stimulating the spread of ownership of British equities in the years ahead.
§ I also have a number of improvements to announce specifically designed to encourage employee share ownership.
§ It is a striking fact that the number of approved all-employee share schemes has risen from a mere 30 in 1979 to almost 1,600 today, benefiting some 1.75 million employees. At present, the annual limits on the value of shares which can be given under all-employee profit-sharing schemes are £1,250 or 10 per cent. of salary up to a ceiling of £5,000. I propose to raise these cash limits to £2,000 and £6,000 respectively.
§ Secondly, I propose to increase the monthly limit on contributions to all-employee save-as-you-earn share option schemes from £100 to £150, and at the same time double the maximum discount from market value at which options may be granted from 10 per cent. to 20 per cent.
§ Thirdly, a number of my hon. Friends have been concerned that current tax law may be inhibiting the development of employee share ownership plans, otherwise known as ESOPs. These are distinguished from ordinary approved employee share schemes by the fact that they use a wider variety of finance, acquire more shares and tend to operate on a longer time scale.
§ I propose to make it clear that companies' contributions to ESOPs qualify for corporation tax relief, provided only that they meet certain requirements designed to ensure that the employees acquire direct ownership of the shares within a reasonable time. I hope that this will encourage more British companies, particularly in the unquoted sector, to consider setting up ESOPs.
§ Those firms with employee share ownership schemes have no doubt that giving the work force a direct personal interest in their profitability and success improves the company's performance. The same benefits flow from profit-related pay. That was one of the reasons why, in my 1987 Budget, I introduced a tax relief to encourage its development. I have some improvements to make to this scheme, too.
§ First, as I have previously announced, I propose to abolish the restriction that, to qualify for the tax relief, prospective profit-related pay must equal at least 5 per cent. of total pay. Secondly, I propose to raise the limit on the annual amount of profit-related pay which can attract relief from £3,000 to £4,000.
§ Thirdly, I propose to enable employers to set up schemes for headquarters and other central units using the profits of the whole company or group for their profit calculations. Fourthly, to help share schemes and ESOPs as well as profit-related pay, I propose to change the 302 so-called material interest rules which may at present unnecessarily exclude employees from schemes where they can already benefit from a trust set up for employees.
§ Taken together, the package of measures I have announced to encourage wider share ownership in general, and employee share ownership in particular, will help to ensure that the idea of a share-owning democracy becomes ever more entrenched as a part of the British way of life.
§ I now turn to life assurance. Last June, the Inland Revenue issued with my authority a major consultative document on the taxation of life assurance. The tax regime for life assurance is unique. The present system dates back to the first world war and has developed over the years in a piecemeal way, leading to a state of affairs in which the incidence of tax is extremely uneven, with some life offices paying no tax at all.
§ There is clearly a powerful case for reform, with a view to securing a tax regime which is more equitable both within the industry and as between life assurance and most other forms of savings.
§ I have considered very carefully the representations that the industry has made, and taken full account both of the changes to the regulation of life assurance proposed by the Securities and Investment Board under the Financial Services Act 1986 and the prospects for increased competition within the European Community after 1992. In the light of these factors, I have decided not to proceed with the more radical reforms canvassed in the consultative document, but I do have number of important changes to propose, based for the most part on the general tax reform principle of seeking lower rates on a broader base.
§ First, many life offices write pension business as well as life assurance, and they are not required to keep the two businesses entirely separate for tax purposes. This enables them to set the unrelieved expenses of the pensions business against the income and gains of their life business, thus giving their life profits unduly favourable tax treatment. The life offices themselves have accepted that this treatment is anomalous, and I propose to end it.
§ This change will come into force on 1 January 1990. Together with some related measures to put the taxation of life offices' pension business on to a proper footing, it will yield some £150 million in 1990–91.
§ The remainder of the changes that I have to propose constitute a broadly balanced package which, because of the transitional provisions, will reduce the taxation of life assurance in 1990–91 by some £100 million.
§ I propose that the expenses incurred by life offices in attracting new business should continue to be fully deductable for tax purposes from the income and gains of life funds, but should in future be spread over a period of seven years. To give the industry time to adjust, this change will be phased in gradually over the next four years, starting on 1 January, 1990.
§ There are certain other, more technical, matters raised in the consultative document which will require further discussion with the industry, and any legislative changes on these issues will have to wait for next year's Finance Bill. But I can say here and now that I propose, as from 1 January 1990, to abolish life assurance policy duty. I also propose, from the same date, that the rate of tax payable on the policyholders' share of the income and gains of life offices, which at present stands at 35 per cent on 303 unfranked investment income and 30 per cent. on realised capital gains, should be reduced to the basic rate of income tax.
§ The net effect of all these changes to the taxation of life assurance will be a cost of £20 million in 1989–90 and a yield of £45 million in 1990–91, rising somewhat in subsequent years. But above all it will provide a more efficient and equitable tax regime for this most important industry.
§ Later this year, United Kingdom unit trusts will be able to compete freely in Europe and will face competition from analogous Community investment schemes here. At present, trusts investing in gilt-edged securities or other bonds face a tax disadvantage. They pay corporation tax at 35 per cent. on their income but can pass on a credit of only the basic rate of income tax to their investors. I therefore propose that from 1 January 1990, as for life assurance companies, the corporation tax rate on unit trusts that come within the new European Community rules will be equal to the basic rate of income tax. Their investors will then get full credit for all the United Kingdom tax the trusts pay.
§ I turn now to pensions. The tax treatment accorded to occupational pension schemes is particularly favourable; and the extent of this privilege has to be circumscribed by Inland Revenue rules. Thus, pension, schemes qualify for tax relief only if they meet certain conditions, notably that the pension paid may not exceed two thirds of final salary: and if they fall foul of any of these rules, they lose all relief.
§ This has the perverse result that tax law effectively constrains the overall pension an employer can pay his employee. This is neither desirable nor necessary. Accordingly, I propose to make it possible for employers to provide whatever pensions package they believe necessary to recruit and reward their employees.
§ However, while it is clearly right that employers should be free to provide whatever pension they see fit, it would not be right to make the present generous tax treatment open-ended. I therefore propose to set a limit on the pensions which may be paid from tax-approved occupational schemes, based on a final salary of £60,000 a year.
§ I have deliberately set the ceiling at a level which will leave the vast majority of employees unaffected, and it will be subject to annual uprating in line with inflation. It will still be possible for a tax-approved occupational scheme to pay a pension of as much as £40,000 a year, of which up to £90,000 may be commuted for a tax-free lump sum.
§ The new ceiling will apply only to pension schemes set up on or after today, or to new members joining existing schemes after 1 June. Public sector schemes, too, will be amended to comply with this. As I have already said, there will now be complete freedom to provide benefits above the Inland Revenue limits, though without the tax relief.
§ The introduction of this ceiling on tax relief also enables me to simplify and improve the rules for the majority of pension scheme members, in partcular to ease the conditions under which people can take early retirement.
§ I also propose to simplify very substantially the rules concerning additional voluntary contributions to pension schemes, or AVCs. In particular, the present requirements for free-standing AVCs place a heavy administrative burden on employers. These requirements will be greatly reduced. Indeed, in many cases employers will not need to be involved at all.304
§ Furthermore, if AVC investments perform very well, occupational pensions may at present have to be reduced to keep total benefits within the permitted limits. I propose that, in future, any surplus AVC funds should be returned to employees, subject to a special tax charge. This will remove the penalty that at present exists on good investment performance.
§ The most important development in pensions in recent years has undoubtedly been the introduction and success of personal pensions. Since July last year, 1 million people have already taken advantage of the new flexibility and opportunities these offer. I have two proposals today to make personal pensions still more attractive.
§ First, I propose to make it easier for people in personal pension schemes to manage their own investments. Second, I propose to increase substantially the annual limits, as a percentage of earnings, on contributions to personal pensions by those over the age of 35.
§ This will be of particular value to those running their own businesses, who are often unable to make contributions until later on in their working life. It will also improve the position of personal pensions in relation to occupational schemes. The new limits will be subject to an overall cash ceiling based on earnings of £60,000, corresponding to the new ceiling for occupational pensions, and similarly indexed.
§ These changes build on, and complete, the pension measures I introduced in my 1987 Budget. They represent a significant deregulation which will allow more flexibility, while setting for the first time a reasonable cash limit on the tax relief available to any individual. They should give a boost, in particular, to saving through personal pensions and through AVCs.
§ Coupled with the changes I made in 1987, this is as far as I wish to go in amending the tax treatment of pensions.
§ Finally, on the taxation of saving, it should not be overlooked that a far-reaching reform which I announced in last year's Budget, to come into effect in April 1990, is relevant in this context. I refer to independent taxation, about which three new explanatory leaflets are now available from all tax offices.
§ There can be little doubt that one of the greatest disincentives to saving in the present tax system is the treatment of the savings of married women. At present a wife's income from savings has to be disclosed to her husband, and taxed at his marginal rate.
§ Independent taxation will change all that. In particular, those married women who have little or no earnings will in future have their own personal allowance to set against their savings income. Independent taxation may well do much to encourage the growth of personal saving in this country.