The Government has finally published its long-awaited plan to “fix” Ireland’s retail investment problem, but it has left out the only two numbers that matter.
The new account will have a tax-free threshold, and anything held above that value will be taxed each year at a “low flat rate”. We are not told the fund threshold, the tax rate or the contribution limit. These, we are told, will be announced with the budget on October 6th.
These are not minor details; they are the meat and two veg of the Government’s retail investing policy. They tell us the shape and nature of the product. Announcing the personal investment account without them is like launching a mortgage and neglecting to mention the interest rate.
The word “low” in the Government announcement is doing a lot of heavy lifting. Low compared with what?
Comparing a “new” 1 per cent annual charge on assets – if that is what the Government eventually settles on – against the “old” 33 per cent tax on capital gains is apples and oranges, like comparing a 1 per cent property tax rate with a 33 per cent income tax rate. One taxes what you own; the other taxes what you earn.
And that is the fatal flaw in Simon Harris’s personal investment account plan.
Take €100,000 held above any tax-free threshold, charged at the kind of 1 per cent annual rate Sweden applies. If your investment earns 5 per cent in the year – a €5,000 profit – a fifth of your gain, €1,050, disappears in tax. That is effectively a 21 per cent tax on your gain. If it earns 2 per cent, the tax takes just over half the profit.
If markets turn and the fund falls 10 per cent, the €1,000 tax is still due, because the charge follows the size of the pot, not the profit or loss.
The current capital gains tax takes a share of money you earn. A charge on the value of something you own – as Minister for Finance Simon Harris is proposing for the new personal investment scheme – takes no account of whether your investment won or lost money.
This conundrum is worse for older investors, as pensioners tend to take less risk because they are more likely to need access to that money sooner.
For a pensioner with €100,000 invested outside their pension, the charge will apply equally whether a high-risk approach earns 8 per cent or a cautious one earns 2 per cent.
As returns fall, the tax eats up more of the pot. This plan will penalise prudence and push the pensioner towards risk simply to make the tax hurt less.
All this is bad enough, but when you add in the effect of compounding, a single percentage point which can look trivial across one year looks severe across 30 years.
An investment of €100,000 growing at an average of 7 per cent every year reaches a pot of roughly €761,000 over 30 years. The same sum growing at 6 per cent becomes roughly €574,000.
The difference in those figures, €187,000, is lost wealth because money taken out of a portfolio now also takes with it every future year of return it would have earned.
A flat charge will not always cost more than capital gains tax, and for many investors it could work out considerably better. After the Government’s big reveal, though, no one can tell because the two numbers that would shed light on it have not been published.
Simplicity is supposed to be central to opening retail investment to the Irish public. What was set out is anything but simple.
Ask how shares in a listed company or money in an exchange-traded fund will be taxed after this reform is put in place, and the answer begins with “well, it depends”. Whether it is held inside the personal investment account or outside it? Whether the amount is above the threshold or below? Whether you will tax it on what it earns or on what it is worth?
Real simplicity is investing €10,000, selling at €15,000 and paying tax on the €5,000. Everyone understands that.
The State has a clear choice between two working models, Sweden’s and the UK’s. On the evidence of the Government’s announcement, we are taking the least attractive element of each.
We propose to impose Sweden’s annual tax on the value of the account and the UK’s cap on what can go into it. There is no sense in launching a scheme that is less attractive on day one than either of the schemes it draws from. We should be learning from other countries’ mistakes, not repeating them.
The UK’s stocks and shares Isa (individual savings account) has been running for decades and surveys indicate Irish investors would prefer it. Copy it and we get a proven account that people will actually open.
The window to get this design right is, on the Government’s own timeline, open until budget day. The Government has a series of choices to make on each element but the public cannot fully understand these choices without all the information.
To allow a full debate, the planned tax rate and the proposed tax-free threshold should now be published. Let us calculate what happens to the accounts when there is a market crash. Let the cautious pensioner work out how their fund will be taxed. Let us see how a personal investment account would fare compared with the traditional capital gains tax on investment, and let investors decide for themselves whether the new rate really is low.
If the Government wants people to invest, give them information they can act on and a system they can follow.
It would be a travesty to build a complex scheme when proven models are sitting in plain view. There is €175 billion sitting on deposit and a generation of potential investors waiting to be persuaded.
Michael Healy is chief executive of IG Consumer at IG Group, the FTSE 100-listed investing and trading platform.