This weekend the Financial Times reported that senior Labour figures had discussed rolling back one of its remaining tax policies.
Namely, the commitment to close a loophole that allows private equity fund managers to claim their million-pound bonuses as “carried interest” (taxed at 28%) rather as income like the rest of us (taxed at a marginal rate of 47%).
What’s likely prompting some to reportedly urge the Shadow Chancellor to roll back? A concern that this could deter investment. Are these concerns well-founded? Unfortunately not.
The private equity loophole stems from a shockingly successful piece of industry lobbying in 1987. Not only is it unfair, some experts even argue that it is unlawful.
Closing the loophole wouldn’t impact average working voters
Taxing private equity bosses less than normal workers costs the Treasury an estimated £600 million every year. Not only would closing this raise funds for struggling public services, it’s one of the ways of doing so that doesn’t impact the average working voter one bit.
The people impacted by this rise earn truly eye-popping sums. In 2020-21 the top 255 private equity execs earned £2.7 billion in carried interest between them, according to law firm Macfarlanes, all of which was undertaxed. If we’re looking for broad shoulders to bear the burden, shoulders don’t come any broader than these.
What’s more, there’s little reason to be worried that asking these extremely wealthy individuals to pay a fair rate of tax would in any way impact investment – in fact we should be asking the opposite. Given we subsidise these firms by hundreds of millions of pounds per year from the public purse, why does the UK still have some of the lowest levels of investment in the developed world?
The fairness aspects of this loophole are clear-cut, so why are Labour in a bind?
Unpicking the ‘investment’ defence
Investment, and how to get more of it, is an area where lots of progressives trip up. The meaning of the word itself is ambiguous. This allows lots of stories to be told about how to unleash investment that sound superficially believable or desirable but actually end up being far from that.
“Investment” has two main meanings. Firstly, it means spending money to create what economists call “capital”. This is the investment that builds factories, lays railway lines, purchases more efficient machines – it expands the ability of our economy to make and do things. The UK has the lowest levels of so-called capital formation in the G7. This is where Labour is rightly concerned. One of the biggest things holding back the UK’s stagnant economy, and as a consequence holding down all of our pay, is a lack of investment in increasing productivity.
The second meaning of investment is more colloquial and perhaps more murky. This is where investment means buying something else – an asset – that already exists. When you hear a foreign conglomerate saying they’ve invested in a much-loved British brand, this is what they mean.
The UK government spent the best part of the 1980s and 90s creating this sort of “investment” as it sold public assets to private “investors”, from state-owned companies to our water networks. You might ask, how does selling something from one person or company to another help the economy and help me? And the answer is, it largely doesn’t and it might actually end up harming you.
The problem with private equity
It is undoubtedly true that some private equity is channelled into the former, “good investment”, via stakes in businesses who need that money to expand and grow.
But private equity often instead tends towards a buy-out culture that fits far more with the latter type of investment, and there are sides to the private equity business that harm the economy, are unfair, and extract from society whilst reaping a profit.
Firstly, some private equity firms love nothing more than to buy an existing, functioning business, strip it for its valuable assets (often property), saddle the newly purchased firm with unsustainable debt, and to let it go bankrupt walking away with the companies’ crown jewels and leaving their former staff out of work. Some recent UK high street collapses were firms that had recently been bought out by private equity.
It’s for this reason that when Shadow Chancellor Rachel Reeves announced she’d close the loophole, she said the firms “asset strip some of our most valued businesses”.
Secondly, some private equity firms engage in so-called “roll-ups”. This is when they buy several different companies all in the same area, reducing competition and allowing them to charge higher prices.
The frontline of roll-ups are currently everyday sectors, often in small towns, like funeral parlours, children’s social care, and dentists. There are towns in the UK that according to the Yellow Pages seem to have lots of different vets for example, but in actual fact they’re mostly owned by the same parent company. Labour’s Shadow Chief Secretary to the Treasury, Darren Jones, recently wrote to the competition regulator to flag concerns about private equity and their impact on competition.
A tax bung won’t help achieve Labour’s missions
Labour should stick to its commitment to close the private equity loophole, and it is welcome that Reeves said the party’s stance had not changed last week despite the FT report.
There’s no reason to assume that a tax-bung to private equity firms will help achieve the party’s missions.
Labour is rightly worried about the UK’s low levels of capital investment, but it should ignore cries from firms who hide behind investment-ambiguity to defend their unfair tax treatment.
In fact, one of the characteristics of Bidenomics that has so inspired Labour has been the US government by-passing financial firms with their investment myths, and incentivising productive manufacturers to make the meaningful investments themselves.
Next time you hear a politician promising that a policy will boost investment, ask yourself, what sort of investment? And how will it help the economy and me?