What caught my eye this week.
Back when passive investing first began to make serious inroads into the active investing orthodoxy – say 20 years ago – its adherents could be testy.
With none of the amiable grace of Vanguard founder Jack Bogle – whose own son runs an active fund – some passivistas would shout down, sneer at, or stonewall any signs of opposition to their creed.
I suppose it was defensiveness.
Now that even a Sunday newspaper will tell you to buy an S&P 500 tracker, it’s hard to recall when investing in index funds was a fringe pursuit. Something best left to people of low ambition and little intelligence, who’d rather a witless robot picked stocks and who’d prefer to run into the buzzsaw of the Dotcom crash than make a few ‘easy’ decisions to get superior returns.
Actually, when I put it that way then, yeah – the active investing diehards could be just as annoying, too!
I remember the balancing act required in moderating comments on this blog. As a person who loves investing in all its stripes – and who picks stocks as much for sport as the hope of a serious return – I never vibed with this ‘with us or against us’ attitude that some readers lent into.
Here’s the evidence, make your own mind up – that’s been my approach.
Passive is almost certainly the best and easiest way for you to achieve your returns. But you do you.
All in it together
Things have calmed down in the last few years. Surely because index investing is no longer an underdog.
Indeed at the end of 2023, passive funds in the US actually overtook active funds in terms of assets under management for the first time.
The rest of the world is close behind, and the direction of travel is clear.
A good few of us still enjoy investing in companies directly or tilting our mostly-indexed portfolios with side bets (and come join us on Moguls if that’s you).
But I honestly can’t remember the last time an arrogant commenter turned up on Monevator calling all index investors complacent idiots. It was years ago.
You do still sometimes see that attitude elsewhere – on hives of S&V like the ADVFN bulletin boards, say.
However I’d suggest the majority of smart retail investors now understand the strong argument for passive investing in index funds – however they run their own money.
The price is right
Even Eugene Fama seems to have taken a chill pill.
The Chicago economist – whose 1965 paper Random Walks in Stock Market Prices underpinned the intellectual case for the first index funds that arrived a few years later – told the Financial Times this week: “Efficient markets is a hypothesis. It’s not reality.”
The FT says:
Fama is surprisingly phlegmatic when it comes to defending his life’s work, echoing the famous British statistician George Box’s observation that all models are wrong, but some are useful. The efficient market hypothesis is just “a model”, Fama stresses. “It’s got to be wrong to some extent.”
“The question is whether it is efficient for your purpose. And for almost every investor I know, the answer to that is yes. They’re not going to be able to beat the market so they might as well behave as if the prices are right,” he argues.
Fama also makes a good point when he admits to some regrets about choosing the word ‘efficient’ to describe markets.
‘Efficient’ sticks in the craw of those who’ve through bubbles and crashes and who struggles afterwards to see an intelligently discounting market at work.
Easy now! You don’t need to revive the old fighting spirit to shout at me. I understand boom and bust is not incompatible with efficient markets. I’m just saying many people do struggle with the concept.
Anyway Fama has the best rejoinder…
“If prices are obviously wrong then you should be rich,” he says.
Have a great weekend.
From Monevator
How historic returns have varied by country – Monevator
Reminder: our member articles have their own archives – Mavens and Moguls
From the archive-ator: How to ensure you won’t run out of money in retirement – Monevator
News
Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.
Workers in UK could get right to request a compressed four-day week – Guardian
UK house prices fall for first time since April, says Nationwide – Reuters
One in three who contested their council tax reduced their bill last year – Which
Steve Webb latest to warn the Budget may come for pension tax relief – This Is Money
10,000 UK homes on ex-military bases were never built – BBC
Graduates struggle in ‘insane’ UK jobs market – Guardian
Crypto owners more likely to have psychopath traits, study finds – Bloomberg
The Home Office has repeatedly spent far more than budgeted for asylum, border, visa and passport operations in recent years – IFS
Products and services
Lloyds Bank raises borrowing limit for first-time buyers – Guardian
Regular savings accounts explained – Be Clever With Your Cash
The premium you’ll need to pay to buy a house near a top school – Which
If Oasis cancels its concerts, will ticket buyers be reimbursed? – This Is Money
Open an account with low-cost platform InvestEngine via our link and get up to £50 when you invest at least £100 (T&Cs apply. Capital at risk) – InvestEngine
Best student account perks and freebies – Which
The ultimate guide to buying a mobile phone for kids – Guardian
Get £100-£2,000 cashback when you open a SIPP with Interactive Investor (T&Cs apply. Capital at risk) – Interactive Investor
Eton warns VAT change will hike annual fees to £63,000 – Sky
Homes for sale with bold interiors, in pictures – Guardian
Comment and opinion
Money market funds are not a free lunch [US but relevant] – Oblivious Investor
Inheritance tax: how to prepare for the Great Wealth Transfer [Search result] – FT
Don’t let this common bias hurt your portfolio – Morningstar
Why you shouldn’t invest like a billionaire – Axios
Vanguard’s sheer size means it’s running into regulatory worries – Humble Dollar
Mr. Market miscalculates – Howard Marks
ISA millionaire status achieved – Fire V London
Why people don’t save enough for retirement – A Wealth of Common Sense
Profiles of couples with $20m or more – Financial Samurai
Naughty corner: Active antics
Past performance is a public enemy – FT
Activism at scale in Japan – Verdad
Media giants are difficult investments these days – Hollywood Reporter
A $557bn drop in office values eclipses a revival of US cities – Bloomberg
Kindle book bargains
The Happy Index by James Timpson – £0.99 on Kindle
Freakonomics by Steven D. Levitt – £1.99 on Kindle
Smarter Investing by Tim Hale – £9.29 on Kindle [£9.29! But rarely reduced]
Rebel Ideas: The Power of Diverse Thinking by Matthew Syed – £0.99 on Kindle
Environmental factors
Have Swiss scientists made a chocolate breakthrough? – BBC
How the heat is changing us – Slate
Fall of the wild – Nature
Home prices in an age of uncertain insurance – Abnormal Returns
Robot overlord roundup
AI giants can learn a thing or two from Mark Zuckerberg – Bloomberg via A.P.
Google AI Overviews rollout hits news publisher search visibility – Press Gazette
Dating apps develop AI ‘wingmen’ to generate better chat-up lines – FT
Aging mini-special
Weight-loss drug Ozempic could slow down ageing, researchers suggest – ITV
Reflections on turning 6-Zero – A Teachable Moment
The Blue Zone distraction – Cremieux Recueil
Off our beat
Perplexing the web, one probability problem at a time – Quanta
Maybe she’s tired, maybe it’s an undiagnosed iron deficiency – Undark
Mr Beast is losing his edge – Sherwood
The Covid-era tech that could reinvent cancer care [Search result] – FT
People just won’t stop blowing up ATMs – Sherwood
Joy – We’re Gonna Get Those Bastards
And finally…
“Missing a train is only painful if you run after it! Likewise, not matching the idea of success others expect from you is only painful if that’s what you are seeking.”
– Nassim Taleb, The Black Swan
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The reason why higher rate tax relief on SIPPs has rocketed is because of perverse income tax cliff edges. If Labour do try and mess with the tax reliefs there will be lots of completely predictable consequences. The biggest problem would be higher earners doing extremely valuable and skilled jobs dropping hours. In Scotland, take home pay 100 – 125k is 30.5%, so unless gross pay was to sky rocket, most people will just drop work until gross pay drops to 100k if they can’t offset against pensions.
I am thinking of launching a new active fund called “Catch them early’. The idea is track the AUMs under various passive strategies, track stocks that are on the verge of transition from a smaller AUM pool of passive strategies, to a larger one.
Active funds playing on the passive movement will be fun to watch.
Broad market capitalisation weighted index tracking (AKA “passive”, which is a misnomer BTW) is the least dirtiest shirt on the washing line. As @AoI #43 said in the comments to @TA’s recently updated article on how country by country stock market returns have varied, it’s down to Bessembinder.
Pick your own individual stocks and unless you have above average luck and/or ability then, statistically, you will likely underperform an index containing those stocks because, as Prof. Bessembinder found for the 3.5 million one-month time periods for the 25,782 stocks that traded in the US between 1926 and 2015, the average stock gained 1.13% per month compared with the one-month T-bill rate of 0.38%, but that average was very misleading since most stocks didn’t make money for that month, and even more lost to the T-bill.
Although, when we weight its market size, the results get a little better, ater a decade, the “skew” was even more pronounced. The average stock gains 118% while the median stock gains just 14%.
Only 37% of individual stocks out performed the US market after a decade. Over the course of their lifetime, just 42% of stocks beat the one-month T-bill.
In terms of total dollars made, just 0.33% of US stocks (86 companies) made up for half of the wealth created by the US stock market over those 90 years and less than 4% of US stocks accounted for the entire market’s gain. It took the other 96% combined just to match Treasury bills.
And the results of Bessembinder’s more recent research for some 61,000 global companies from 1990 to 2018 is even more stark in showing the effects of return skew, indicating that skewness is actually getting more pronounced, such that there’s ever less chance of the median (and typical) self selected ‘actively’ managed individual company portfolio outperforming the relevant index or set of indices (and, indeed, of outperforming the mean market portfolio).
So going ‘active’ means playing with a dice that’s weighted against you. Why would you do that? The cheaper fees are just icing on the cake, not the reason to go ‘passive’.
And more recently there’s Michael Green’s work highlighting the research on the effect of passive flows (which I’ve linked to before in recent threads) in the context of the Inelastic Market Hypothesis which does present a plausible case that passive share is changing the macro structure of markets leading to less liquidity and more volatility in the biggest names in the index and a relentless price insensitive bid which make it ever harder for active managers to beat passive indexers
Mr Green does, however, think that if passive share continus to rise (and goes much above 80%, 85% ish) then it could lead to market collapse when auto contributions to stock market index tracking retirement default funds start to be outweighed by decumulators drawing down in retirement – but, in his view, probably not before a potentially massive run up in the index with accompanying P/E expansion (perhaps also part explaining why CAPE seems to have failed since passive indexing began taking a decent share from the 2000s).
Considering the wider demographic challenge that’s been discussed on here at length and the drive to keep people in the workplace, if not increase the working population, you’d think reducing incentives to work through changing the pension rules would be completely off the agenda. It seems this idea of “pension tax relief” is sticking though. To me, and I’m sure many on here, it fundamentally changes what pensions are all about. Pre-tax contributions, taxed withdrawals. If that were to change I’d have to rethink my whole income philosophy. Rather than deferring via a pension I’d be likely just to reduce it now.
I’m fortunate to be in the 60% band but keep my taxable income below that threshold via pension contributions. An additional consideration not often mentioned is that £100k is also a threshold for childcare. So >£100k taxable income would also lose me 30 hrs a week childcare and 20% off the remainder. Fair to say £100k is a huge cliff edge that I’m not prepared to go over. 4 days a week or unpaid leave would be a solution that I’m sure many would consider. If I was on the cusp of FIRE I’d jump at it and if I was already RE there’s no way I’d come back for pennies in the pound.
Re: an end to higher-rate pension tax relief, I’m currently musing that my focus would probably shift to paying off my mortgage rather than stuffing my pension, after ISAs and some modestly efficient pension contributions.
I also can’t see me killing myself to earn an incremental £10,000 if nearly half of it goes to HMRC without the prospect of tax relieving it away.
At the least I’d need a flat rate 30% to offer some hope of lifetime tax bracket arbitrage.
And I say all that as someone who is actually very sympathetic to the new government’s funding predicament and the need to find money from the wealthier, somehow. (And yes there are other things it can do).
Incentives rule everything.
@Delta – but if indexes ever started to “collapse” for reasons like that active would rapidly swoop in and find the right price. It’s just not possible for a top global company to collapse in price with no actual fundamental reason, if that happened there could be a situation where dividends were a massive percent of the share price as profits were maintained.
Re: pensions. To be fair we have these headlines every single year now. As of 22/23, the HMRC was calculating pensions tax relief as £27bn in terms of lost income tax and £28bn in terms of lost NI (https://committees.parliament.uk/publications/41067/documents/200054/default/). These are the second and third largest non-structural tax reliefs after private residence relief.
If the public want more spent on public services, they need to pay for it. If you’ve already hit CGT and IHT, then pension tax relief is just too big a line item not to trim in some way. Hitting those who use it to avoid paying 40/45% tax is more progressive than other forms of tax and (unlike many forms of tax) can actually raise a non-negligible sum. Even ISAs are starting to get expensive to HMRC. That was <£2bn in tax relief a decade ago; it will exceed £10bn in the next few years.
I'd prefer to see public sector spending cut back hard but the way it's evolving right now, they will have to raise taxes and cut spending. Until the public actually gets real about the type of public services we can afford, expect continuous salami slicing of tax reliefs and more fiscal drag.
I don't see they have much choice really, since levelling with the public on NHS/social care/state and public sector pensions is an instant path to political oblivion.
The other tax efficient savings vehicle in the UK is one’s primary residence, if the tax relief on pensions and ISAs is reduced, does that not increase the incentivise for people to plough money into that instead and potentially pushing prices up? (as indicated by The Investors comment that he would pay off the mortgage)
We know that British public have a love affair with property, but against the view that that house prices are too high, it seems counterproductive.
A tax on gains on primary residence is what the government should consider but would surely not dare to…
@Marco #6: quite possibly but maybe not.
Check out the 3 research papers linked to in my comment #41 (of 26th August) to last weekend’s weekend reading.
Suspect that net flows and available liquidity matters as much in the short term as fundamental value analysis does over longer timescales.
As active share continues to decline then there is going to be ever less price sensitivity and less ability for active fund managers to correct imbalances, whether to the upside or the downside, as they won’t have the fund ‘firepower’ to do so.
Not saying that Michael Green is actually right here, but it’s worth IMO checking out his recent interviews with Rational Reminder and with Michael Gayed on YouTube and his substack for a fuller picture of what he’s saying.
With Peter Thiel in February 2018 he did manage to make a reputed $244 million on a $250,000 stake (premium) using a put options bet (at the end of 2017) that the IVIX (inverse VIX) ETF (with billions invested in it at the time) ‘mathematically’ (as he says in his interviews) had to go to zero within 2 years; and within a couple of months it did (the 2018 Volmageddon episode).
So I don’t myself dismiss his concerns out of hand – but I’d agree that, on face value, the idea that passive share could take itself and the market down does seem rather farfetched.
But, then again, didn’t people think that about AAA rated CDOs, CLOs and other MBSs before 2008…?
ZXSpectrum48k, on the proposed tax on pension contributions you state ‘HMRC was calculating pensions tax relief as £27bn in terms of lost income tax and £28bn in terms of lost NI’.
I believe ‘lost’ is an erroneous verb to use for such a calculation; suppose pension tax relief was scrapped altogether, the taxman would get only a fraction of that amount, with a good old socialist economy collapse on top.
Therefore the above 55bln £ ‘lost’ is only a notional figure when seen into an HMRC excel, and an emotional headline aiming to test the waters when seen in the press.
As a millennial deep into that 42% territory, I find the proposed 10% tax on my pension contributions unethical. I hear private pensions were introduced to allow people save for retirement, hoping less citizens will be in need of state support during old age. The proposed policy is absurd when the very reason why we have tax relief on pension contributions is considered.
In addition, while 10% may not seem high, I feel it is some sort of ‘Rubicon crossing’ allowing for further increases in the future. It also deincentivises further career progress, a millennial or gen z locking money into their pension today takes a 20-35 year bet on lifespan, health, markets, tax policy, pensions policy, and geopolitics; remove the tax incentive and I personally do not subscribe to the resultant risk/reward ratio.
I find several of my peers who are also boiling into the same 42%/60% marginal rate pot, are also concerned on a similar way, many of us are already rethinking our whole life approach, or just relocating to the likes of UAE/Singapore etc.
Well, I think a 30% tax relief scenario for pensions would be a sensible solution. Why should people on median salaries subsidise people of multiple six figure salaries?
And include them in IHT, they’ve been perverted to some IHT dodge
Then require RMDs as per the US. Make sure people take out the money and repay some of the tax relief they received in the way in.
Include primary residence in IHT.
Each individual to get a £250k IHT allowance. Rest taxed at marginal rate.
Reduce ISA allowance to £10k p.a. and a maximum lifetime contribution of £150k.
Index link all this in the primary legislation.
That’d be a good start.
Thanks for the great links, as usual.
Like @Marco, I control my earning to target £160k and work 4 days a week and £60k max pension. I’m an outlier and a weirdo. Without the £60k allowance hike I would have been really stuck. There are huge distortions for me. I would happily work 5 days a week but if I do so, I am effectively working for a low per-day rate of pay than 4 days – I am not taking an effective pay cut to work more, that is crazy. It’s actively disincentivised by the tax system.
£100k today backwards to 2004 prices 20 years is ~£58k – a decent salary but hardly footballer money. Ironically, I am not actually earning much more now than then in real terms. And while you can live well on that money for sure, in London you still have to pay attention.
If/when flat rate pension tax relief comes in, I am not sure what I’d do. It would cost me many thousands each year and over the rest of my working life, hundreds of thousands both in tax and lost pension pot. I could afford to just quit my job and retire in a few years at 50 – I work in finance but since Brexit, my job would almost certainly not be backfilled in the UK. It would be a lose-lose for the UK and for me.
The biggest irony I think with flat rate pension relief is the notion it would encourage basic rate tax payers to contribute more because they get “free” money. But those earning ~£30-40k a year need every penny and if you try a tell people to live on a £100 less a month because they’ll get £140 in another 25+ years, guess what choice they’ll make?
Still, I think the raid on pensions is inevitable. It’s been bandied about for long enough. And I wouldn’t discount ISAs being targeted either in future when that raid doesn’t suffice (which it won’t). It’s great some people reach £1M ISAs. Good for them. But the tax man and future legislators can’t help but see a big fat juicy top up for the public purse. Can they resist? Do they even have a choice? Who would argue against taxing ISAs over £1M, or £500k, or £250k? You people are already way too rich not to pay more tax. So, cough up.
Interestingly I am in Slovenia at the moment and while discussing money with a local retired paediatrician and her civil engineering/developer husband (my generation late 70s) -their savings are all in property ( 3 houses) which they don’t let out but live in on a rotational basis
In this part of the world people have been so traumatised by currency “fiddles” by various governments of different hues that property is the default fall back position for investment
Adulteration of savings and pensions etc has been much too common
Perhaps things are changing for the present generation but folk memories are long and the young seem to be following the same path
It couldn’t happen here could it?
xxd09
On the possibility that the autumn statement might restrict higher and additional rate relief on pension contributions, it does seem like the drum beat is louder and more persistent than in previous years. I imagine the Treasury are seeing how different ideas land in the media. Assuming it did happen, would a solution for HRT payers earning £50,270 to £100,000 p.a. not be simply as follows:
– Use SIPP to make a pension contribution up to the BRT/HRT threshold – i.e. for the £37,700 p.a. from £12,570 p.a. to £50,270 p.a. which is taxed at the BR.
– Above £50,270 p.a. use VCT (or possibly EIS) for 30% relief with no tax (for VCT, but not EIS) on the dividends.
– If 30% relief above £50,270 p.a. is not enough for you, then split between VCT (30% relief) and SEIS (50% relief, plus tax deductable losses at highest nominal rate paid)
SEIS invests into B*tS*** high levels of risk of failure new small companies, so it’s definitely not everyone’s cup of tea (I’ve dabbled with SEIS for one tax year, and investee company profiles are straight out of Dragons’ Den). Not a ‘widows and orphans’ investment for sure.
But even if you restrict to only using VCT for income over the BRT/HRT threshold, you’re still getting 30% relief against 40% tax paid at HRT, and the dividend income stream is tax free.
It wouldn’t be so bad really (not great, but not the end of the world either).
@Delta I appreciate the sentiment and creative thinking. I am a cynic on VCTs and few in my research even manage to claw back their 30% tax relief – you’re right it’s elevated risk and more so still with SEIS. I’d probably take my chances, pay and the tax and stick what paltry I have left over into a S&P500 tracker/ISA than tamper with VCTs. But I’m abnormal and I know others who’d bite the arm off your suggestion.
Property is interesting but given last week’s round-up and the appetite for a “mansion” tax, I am not sure that’ll escape either (and neither has it either with second homes, stamp duty etc). And as people found out again after Brexit (sorry!), UK property is denominated in well, UK currency… So I conclude global diversification is the only real defence against UK economic incompetency risk.
Most of all, a raid on pensions – either directly (re-introduce LTA) or via tax relief would be a shot across the bow and break the taboo that tax sheltered savings are sacrosanct. That would be a serious reputational signal akin to a “default of trust” with past generations of policy. But as @xxd09 says about Slovenia, perhaps Britons are steadily becoming conditioned to being screwed over financially by successive governments (regardless of political affinity) to expect less and less.
OK OK, my cynicism is dialed up to 11 right now 🙂
Sam’s $20m stories were interesting but unsurprising: big tech, big banking, and real estate, with a dash of inheritance & grift!
The required minimum distributions (as is case in the US) feels like a good solution here. You can leave contributions pre-tax, but requiring folks take a certain amount (say 5% per year) at pension age would accelerate the tax take on pensions and mitigate some of the issues around large pensions escaping IHT. The government would have a large increase in predictable taxable income arising from this, while not creating disincentives to work or save for retirement.
I briefly touched the 60% band around a decade a go – and went part-time to avoid it. Decided I liked part-time, and kept at it even though I’m no where near troubling the 60% threshold now.
Like most, I’m happy for others tax avoiding vehicles to be hit as long as mine are left alone. I no longer use ISAs because being closer to retirement age, pensions looked like a better choice and that’s where my S&S investments ended up. A cash ISA has barely been worth the effort over some of the NS&I tax-free offerings.
Overall, the govt needs incentives to encourage the average person to save for their future, but the wealthy quickly figure out how to exploit them too.
@ LondonYank
Agree the RMDs seems like a sensible way forward – we should also give serious thought to apply CGT on death, that way we can give some flex on IHT.
Re flat 30% tax relief on pension contributions – it seems sensible to me:
– tax /Ni savings are close to 30% anyway
– given the state pension will use all the TFA it will be taxed at 20%. So a 10% incentive is needed to save for retirement
– HRT payers are mostly (90%+ likely) going to be BRT payers in retirement so giving them 30% rather than 40% levels the incentive to save.
– if you’re on track for HRT in retirement you can afford to give up some tax relief.
– And once you’re on track to use up all your BRT allowance in retirement making further contributions doesn’t make sense
Now all we need to do is set the max DB/public sector pension to be £50270, or whatever the start point is for HRT. Or some other method of taxing the funding contribution from the state/employer.
If taxing gains from previous years (surely not!), any announcement about limiting the tax free amount in an ISA would have to come into immediate effect (not always easy to do), as otherwise everyone would simply withdraw tax free down to the threshold (e.g. £250k) before it comes into force – which would greatly reduce the amount that could raised in the short term which is where their focus primarily lies.
I suppose it would mostly likely be implemented on a forward-only basis, i.e. next year you will be taxed on gains during the year on the % of your isa that was over the threshold at start of tax year.
The non-structural tax relief estimates in the paper linked by ZX (#7) ultimately claim that they have been compiled iaw Table 6 of the Private pensions statistics publication. The latest version of this (July 2024) is available at: https://www.gov.uk/government/statistics/personal-and-stakeholder-pensions-statistics Please also note that the figures are frequently revised and are explicitly labelled as estimates*.
From the Notes to Table 6 (at the link) you can see that the “Total net pension Income Tax and NICs relief (A) is the estimated cost of Income Tax and NICs relief on pension contributions and any investment growth within pensions (B), less the Income Tax paid on payments from pension schemes to those accessing their pensions and any tax charges arising from breaches of the annual and lifetime allowances (C) such that A = B – C”.
That is, it is an in year (balance sheet type figure) that nets off the costs of that years reliefs (tax & NI, employer & employee) vs taxes raised from pensioners that year. This, unfortunately is not the cost to the government of said reliefs. For each pensioner that figure can only be properly calculated after the event, ie once the pensioner has expired and is actuarial rather than balance sheet in nature.
A simple example follows: I recently started paying taxes from my pensions but the reliefs I got date back roughly between one and four and a bit decades. This situation will hopefully continue for a good number of years until I leave this mortal coil. In the vast majority of cases, in any one year, you either receive reliefs or pay taxes, but not both; think accumulation followed by de-accumulation.
These estimates should carry IMO a significant health warning, and I suspect the government actuaries are well aware of the likely overall costs (if any) of said reliefs. Sure there is an apparent in-year cost to deferring tax, but that is definitely not the price of the practice overall. Around 1.5% of GDP (a seemingly fairly consistent measure) to encourage pension savings does not strike me as being as onerous as the alternatives.
I suspect the headline figures are promoted by HMRC to make a point. Beware!
This would not be the first time that politicians have decided they rather like a seemingly simple idea of hitting pensions but, in all previous cases it has never ended well for the pensioners. This new wheeze however, might also hurt the government (as well as pensioners) as the near guaranteed income tax stream from pensioners may in the longer term start to just fade away.
*not to mention Home Office estimates for asylum, border, visa and passport operations that some may call fantasy figures
@AvB
I think the lifetime cost (foregone tax) of all the current and future money in ISAs is much bigger number than people think.
It’s a little hypocritical of me but I’m supportive of some cap on ISAs. There’s loads of options:
-no new money if balance is > £x
– all money removed to be below a limit £y, say £250k (nightmare scenario for us types)
– max lifetime subscription of £100k etc
A massive tax simplification would be a good start – no weird cliff edges and incentives to down tools to hit arbitrary income targets.
@Boltt (#19):
See: https://www.pensionsage.com/pa/One-in-five-pensioners-to-be-brought-into-higher-rate-tax-band.php#:~:text=The%20analysis%20showed%20that%202.7,people%2C%20are%2070%20or%20over.
I have just skimmed the paper.
FWIW, I suspect we might see frozen thresholds further extended in the budget – which would seemingly just increase the 20% figure!
Some 55% of energy generated from power stations in the UK last year was lost in conversion, distribution and within the energy industrial complex (mostly as waste heat from central generation rather than decentralised energy generated where needed), amounting to over 38 million tonnes of oil equivalent, which is worth nearly £20 billion. This is around the same number that Rachel Reeves identified as the ‘black hole’ in the UK’s public finances, the options for filling which are causing the angst in the comments here.
As long as we lack real ambition to improve the country in a way that allows sustainable growth through real efficiencies and productivity gains then we’ll be doomed to a downwards spiral of an intergenerational fight over which spending cuts and which tax rises to make and how much more to borrow to cover recurrent expenditures (as opposed to borrowing to invest in genuine return producing projects).
The UK can’t go on like this, whether it’s the Tories or Labour in charge. We need to unleash Keynes’ animal spirits, and not argue over how to split up a shrinking pie.
@DH (#24):
Re: “The UK can’t go on like this, …”
You are of course correct.
However, this requires leadership by innovators rather than second rate (at best) administrators!
I personally think that a cap on pension tax relief is very unlikely because the effect it would have on civil and public servants paying HRT. The immediate impact for them would be a cut in take home pay – and next the unions calling for mass strikes. Not saying it’s impossible but it would be tricky.
More likely would be some tinkering with tax free cash limits and IHT treatment
@Speculourous. I don’t agree that spreadsheets don’t matter. As Truss and Kami-Kwasi found out to our cost, what is in these spreadsheets really matters. Yes, HMRC/govt revenue forecasts from tax reliefs are a form of make believe but credible make-believe is still required by the markets.
@AlCam. I think we all understand that these HMRC numbers are not what would be raised by removing/reducing them. There are complex feedback loops, impacts from crowding in etc. When govt expenditure is £1.2 trillion+ a year, though, then any tax relief measured in the tens of billions must be on the target list. You can have a bonfire of other smaller tax reliefs and still on raise <1% of the budget. Raising a few hundred million or even a few billion just doesn't cut it.
I also agree with you and @DH that "the UK can't go on like this". You cannot, however, just blame the "second rate (at best) administrators". I'd say we need to also blame our second rate (at best) electorate!
@ZX (#27):
Re “@AlCam. I think we all understand that these HMRC numbers are not what would be raised by removing/reducing them”
You reckon? I am pretty sure, amongst the believers are many hundreds of MP’s including quite a lot of ministers of state too!
FWIW, I reckon they will plump to extend the freeze on allowances, etc as it is easier and will raise far more cash too. As Steve Webb mentions (in passing) in his post, the “promise” re income tax seemingly refers to rates!
And, yup, we are all to blame!
@Nebilon #26: might Reeves not just exclude DB schemes from any withdrawal of HRT relief? That really would be “two tiers”, but we already have a degree of two tiers between DB and DC in practice. She could even introduce a 25% or 30% rate for DC and keep the present 20%/40%/45% for DB and call it fairness.
@ZX, @DH, @Nebilon, et al:
Putting aside the veracity of the HMRC figures, Table 6 (see #21 above) may be quite informative. It categorises the figures in a number of ways including: employee vs employer; public sector vs personal pensions & private sector; DB vs DC; relief at source vs net pay agreement vs salary sacrifice, etc. It also IMO interestingly explicitly breaks out reliefs on: investment income of pension funds & deficit reduction contributions (DRC). I think the DRC breakout may be new to this issue.
Tend to agree with @Nebilon that “some tinkering with tax free cash limits and IHT treatment” more likely than changes to reliefs; but still think they will opt for extending the freeze on allowances, etc. But who knows?
Huge structural changes in order to reduce pension tax relief is a terrible idea from a policy perspective and will have many unintended unpleasant consequences. For a start it will be a nightmare to implement, since it introduces a morass of new complexities into calculating tax reliefs, and upend how most pension contributions are made. It will greatly reduce incentives for pension saving (which mostly come from middle band taxpayers for good reason – those in the lowest band cannot afford to significantly increase savings), introduce further disparities between DB and DC pensions, contribute towards yet more massive intergenerational inequalities, and result in perverse incentives which will damage the economy in other ways. Even lowest band earners are fooled if they think they will really gain anything from this, since on salary sacrifice their tax relief is already 28%. If, as is speculated, a new relief level will be fixed at 30%, Reeves can raise the same money from pension contributers much more straightforwardly and with far less political blowback through other measures such as reducing the annual allowance.
Unfortunately, this proposition is cheered on by many (eg the Fabian society) and then repeated uncritically by people who seem to know next to nothing about pension mechanisms or good fiscal policy and so believe such measures are simple and that double taxation is ‘fairness’.
> Some 55% of energy generated from power stations in the UK last year was lost
As you’re well aware @Delta – because you’re a smart cookie – while that is certainly true, it’s no small technical challenge to improve. It certainly would never be zero because… well, physics. And take probably decades to dramatically reduce that figure at the cost of hundreds of billions.
I think you’re right that it needs to be done and highlights the weakening of the environmental agenda which should still be a priority. But herein lies the rub – that “nonessential” spending got cut as the country became good enough or couldn’t afford to carry on, and that creates a negative feedback loop – not making investments like this which would reduce long term costs and keeping Britain shackled to expensive inefficiencies or otherwise held back relative to her peers (yes HS2 I’m looking at you).
@AvB on ISA capping – unfortunately I think you’re missing the wrinkle that if people did draw down large ISA pots to avoid some cap, that money has to go somewhere. Unless it goes offshore, it’s going to end up in a taxable account either prone to CGT or interest bearing etc. Unless the holders just radically change risk profiles stuffing into gilts or VCTs etc which would be crazy.
You’re also missing that HMRC has a long history of introducing taxes at the thin end of the wedge. e.g. dividend tax which starts out “small” but steadily gets ratcheted up over time.
I actually think the biggest defence against an ISA cap is – as others allude above – their are enough politicians and peers who’d be in the crosshairs to push against it.
“Some 55% of energy generated from power stations in the UK last year was lost”: yeah, well, that’s what you get for using heat engines. It was C P Snow who argued that people who don’t understand the Second Law are essentially uneducated.
Obvs you could, in principle, cut the losses by replacing a heat engine by a fuel cell. Alas, nobody has a clue how to build a fuel cell that consumes natural gas directly.
I’m not much impressed by arguments that boil down to “and now we assume a technological miracle”.
As with many things in the social media landscape, there seems to be little room for nuance. Everything is either black or white. Post about anything active and you’ll be met with responses of why not just invest in SPY, QQQ etc. (I even saw one comment recently that admonished active investing & stated that the poster should be all in on SPY with 30% leverage!).
As with most things in life I’ve come to learn that we live somewhere in the shade of grey. My SIPP is entirely in indexes. I have around 25% of my ISA in investment trusts where I think these offer something that passive (or myself) can’t. The rest of my ISA is in individual stocks. Would I be better off in SPY. Possibly. But I enjoy researching investments and commiting my savings to this. I also think having too much exposure to an American Market that is looking punchy in valuation terms might not end up well. I accept that I could well be wrong.
I view my approach as having split my assets between faith in the market as a whole, faith in some professionals and faith in myself. All of them will let me down at some point but hopefully not all at the same time (apart from the short periods when the entire market sells off).
I think investing is about finding what works for you. I can’t understand the legions of passive investors who seem to spend all day shouting at people that do anything active. Nor can I understand why momentum traders (who have a habitat of calling themselves investors) go around promoting short termism and high portfolio turnover. If it works for them and they are happy with it, shouldn’t they be just getting on with it without howling at other people on social media.
PS. Cliff Assnes gives an interesting account of the folly of calling markets efficient here: https://open.spotify.com/episode/0cGLIc2A2cw1Dcmy0r7Tm2?si=esc8sQz8QdGEzuReH9xBFA
@An Admirer #32, @dearemie #33: We have to try. All progress is endeavour. Climbing the mountain to see what’s in the next valley. Hollowing out the log to get to the next island. Despite the rest of the tribe saying that it was too dangerous, that it would take too long, or just be too much effort to bother. We have easy wins with home insulation, improved building standards, switching to LEDs (Hansard, House of Lords, Vol. 827, 9th Feb 2023, Lord Markham “if we put LED lightbulbs in every hospital, it would cost £400 million and save £100 million a year. That is the sort of thing private capital will fund every day of the week, probably at a 5% yield, giving us £95 million of savings a year”). We need to aim for energy abundance. Closed fuel cycles with sodium cooled fast neutron reactors, molten salt cooled reactors, very high temperature reactors, small modular reactors and advanced modular reactors. Using thorium as well as uranium. Massive adoption of solar farms especially in areas of high solar irradiance and low maintenance costs. On and off shore wind where wind speeds are reliable and sufficient. Micro generation where cost effective. And keep funding research into both tokamak magnetic confinement and pellet ignition fusion. As a species we should target increasing primary energy production from 18 Terawatts globally now to 100 Terawatts by 2100 (2.3% p.a. by my back of the envelope maths), and aim for 95%+ through low to near zero carbon technologies. That gives everybody the power consumption of a West European and potentially the same standard of living (if not higher with more efficient energy use). I’m not prepared to accept the declinist, stagnationist proposition that we end up fighting – figuratively or literally (or both) – over an ever dwindling (or forever fixed) quantity of financial, physical and energetic resources. Ingenuity is the ultimate resource: “Do not go gentle into that good night, Old age should burn and rave at close of day; Rage, rage against the dying of the light.” (Dylan Thomas)
@Delta Hedge #24 “Keynes’ animal spirits”
For interested readers, see also Animal Spirits, Akerlof and Shiller, 2009 Princeton University Press.
Excellent links this week as always. Thank you @TI.
On Bloomberg’s US commercial property piece; the saying amongst building owners/ developers, apparently, is “Just survive till Twenty Twenty Five”, so great is the need for deep rate cuts next year. Time’s up for “extend and pretend” financing.
On Verdad’s piece, the Japanese market has gone from uninvestable super bubble, back in 1989, to a deep value play by 2024, especially in smaller caps. I hope you don’t mind me giving another quick shout out to the free Altay Cap Substack which covers micro and nano cap Japanese stocks with quality/wide moat and/or growth aspects to compliment often unfathomable cheapness.
But, Delta Hedge, many of the things you recommend will just be a component of a heat engine and therefore won’t answer your complaint of 55% of energy being wasted. The Second Law doesn’t care about your source of heat – it could be nuclear, or combustion, or geothermal. It, and its corollaries, tell you how much of it you can turn into electricity, to wit a bloody sight less than 100%.
We can do better than 45%. Combined cycle natural gas plants capture and use the plant’s own hot exhaust gases to spin a secondary turbine generating additional electricity and get to 60% efficiency, and hydro plants channel water direct to turbines, with little conversion loss, thereby reaching 90% efficiency. A tenth of all electrical production is lost in the grid. Superconducting cable systems would allow high-efficiency bulk power transmission over long distances, with none of the resistive losses encountered in conventional high-voltage lines and cables. And we massively waste the energy arriving in homes and businesses through poor insulation and outdated equipment and processes. Forget the (hugely important) environmental aspect. We’re literally wasting money.
More relevantly though, why are we using low density non renewable fossil fuels? This is 19th century tech. Granted that modern nuclear plants struggle to get over 45% total efficiency of conversion (but coal’s only 32%). However, whilst coal maximally yields 25 megajoules per kilogramme, natural gas 42 to 55 megajoules per kilogramme and kerosene 46 megajoules per kilogramme (each one for total combustion); we can get 82 million megajoules from fissioning a kilogramme of uranium using breeder reactors to turn the ‘waste’ of each fuel cycle into fuel for the next. And if we get sustainable net gain fusion burn then a kilogramme of deuterium-tritium fusion will generate the energy in about 2,400,000 to 2,600,0000 US gallons worth of oil – up to 337 million megajoules, more than 10 million times higher energy density than the maximum from coal, and from isotopes of the commonest element in the universe.
@Delta Hedge
Forgive me, but since you are a seeming fount of so much in-depth knowledge, I sometimes find myself wondering whether you are actually AI generated?
😉 [Apols for typo in last post. It should be “2,600,000”. Missed removing extra zero before ten minutes up]. “
BTW this free eBook is a decent source on the energy issue.
Title: “Energy and Human Ambitions on a Finite Planet”
Permalink:
https://escholarship.org/uc/item/9js5291m
ISBN
978-0-578-86717-5
Author: Murphy, Thomas W, Jr
Publication Date: 2021-03-11
@Nebilon #26 certainly within the NHS pension scheme the higher earners already subsidise the lower earners via higher contribution rates (which is no longer justified since the transition to Career Average Revalued Earnings rather than Final Salary schemes, everybody is getting the same pension proportionate to their salary). BMA already vehemently opposed to this.
Loss of HRT relief with be a double-blow, especially as they don’t have the option of reducing contributions to mitigate the change, only withdrawing from the scheme altogether (or straight-up retiring early or reducing work hours as was becoming a big issue pre-LTA abolition & annual allowance increase).
Overall I cannot help but feel any reform in this area is ultimate short-termism. The upside for lower earners is unlikely to materially change their position in retirement – so the state will still be bearing a large part of their costs. The downside for higher earners will incentivise some to emigrate, and leave others with less in their pensions diminishing their economic contribution in years to come (and potentially leading to greater burden on the state when said smaller pensions run out). The downside must be greater in magnitude than the upside or it wouldn’t be worth doing as a cut.
@CollReg. So if, for example, high earning NHS staff should not pay more via lower pension tax relief, exactly how are we funding these public services?
Public sector productivity is running well below inflation. Add that to above inflation salary rises and you’ve got a real cost that has to be paid for. Demographics imply that spending on the old (NHS, social care, state pensions) will rise about 3% of GDP over the next 15 years. So another £100 billion per annum in real terms by 2040, just to stand still.
If we cannot increase income tax, NI, VAT and now also pensions are off the table due to all this “fairness” and “morality” stuff, where is the money coming from? IHT currently raises £7.5bn. CGT £15bn. So changes to IHT and CGT cannot raise £100bn. Forget VAT on private school fees filling the whole. Borrow more through Gilts?
I just think people are not seeing the magnitude of the expenditure issue the UK is facing. Take the NHS as an example. NHS funding increased fourteen fold in real terms since it was created in 1948/49. NHS spending went from 3% of GDP in 1960 to 8.5% in 2020. Helpfully, that was offset by defence spending dropping from 7% of GBP to just 2% of GDP over the same period. That “peace dividend” cannot be repeated. What are you going to squeeze this time?
It’s unpalatable but I think everyone just needs to accept they will pay more to get less.
@ZX – rejoin EU = £40 bn p.a. additional tax now on £100 bn p.a. (~4% GDP) of lost output (Bloomberg Jan. 2023). That leaves growing the economy by another £150 bn p.a. (~6%) over and above its post-2020 (and, FAPP, post-2007) dismal trend in order to raise the last £60 bn p.a. tax yield. We need ambition. We need courage. We need boldness. We can do it. We must do it. If we don’t try, then we definitely will fail.
Boris was a harbinger of Britain’s Peronist phase. Rampant clientism. The Tories indulge the elderly with triple lock, culture wars and dog whistle politics whilst threatening the young with National Service. Labour indulges the public sector unions. Its not a question of right or wrong, virtue or vice, but just what works and what doesn’t. Without getting per hour productivity growth back to 1950 to 2007 (and ideally 1950 to 1973) rates then we are all screwed.
Suggestions.
Sack Andrew Bailey and put in Andy Haldane. We need someone with intellectual energy.
Build those power stations and a new grid. Borrow to invest and not for current spending. If we have to cut pensions and benefits to pay for infrastructure upgrades so be it. Likewise raising taxes. The markets will understand the rationale.
Address the long tail of barely profitable smaller companies.
Implement a UK version of DARPA.
Adopt an industrial policy like Bidenomics but more so. We need to go full on Keynes. We won’t cut our way to growth. Austerity doesn’t work even in its own terms
On the power stations, abandon the ludicrous Linear No Threshold model of ionizing radiation, and explain to the public what the evidence actually supports, i.e the radiation hormesis model. Amend design requirements accordingly, bringing down costs and allowing roll out at scale per an accelerated version of France nuclear power industry but with SMRs permitting a rapid ‘learning cycle’ of cost and scaling efficiency per Theodore Wright’s Law for forecasting cost declines as a function of cumulative production.
Brexit is an elephant in the room, but advocating for a return to Europe / pointing out the costs will only be answered by the usual cries of Remainerism and “get over it”.
I — and many more qualified than me — said Brexit would cost this economy dear. Perhaps it might have helped if others had put the same emphasis on the slow bleed / puncture analogy. It is certainly very hard to unpick the counterfactual due to Covid disruptions, but we have credible guesstimates from the OBR and the likes of Goldman Sachs that as DH says put the cost at £100bn 18 months ago, for £40bn in lost tax. We’ll be higher now (in counterfactual terms, not ‘but we’re doing better the last six months than Germany innit’ terms).
It’s pretty perverse. You say Brexit will weaken the UK economic machine. The machine demonstrably is stuttering like we haven’t seen for 30 years in the face of the escalating costs as @ZXSpectrum48K so clearly lays out. And yet many people still want to see a coincidence.
I guess the problem was always going to be that the impacts (as I saw them anyway) were always going to come down the line. Well we’re down the line and here they are.
The benefit-free Brexit is a big reason why we’ll all be paying more taxes by the end of the year.
At least Leavers can take comfort in the fact they voted for it.
[p.s. Sorry for all the typos in v1 of this comment, if you were emailed it. I can’t even blame wine this time!]
#3, #9 and effect of indexation on market liquidity and prices: Klement on Investing today thinks that the effect is both real and significant, albeit not as dramatic or rapid as in Michael Green’s narrative:
https://open.substack.com/pub/klementoninvesting/p/the-butterfly-effect-index-funds
If there is a macrostructural bias towards higher prices in the large caps in the most heavily passive share markets, then I want exposure to that process through either cap weight or momentum weighted indexation.
Ah, well.., another academic study.
How about those who voted to leave get a new tax bracket to pay for their decision.
I think any CGT changes will roughly make zero difference, and could actually reduce the total income, as most people will have rearranged their affairs when a high tax impending labour government was impending Starmer denied that they would, but that was always a guaranteed u-turn. It also has the chance to reduce investment by company owners – I’ve been one for more than 20yrs and do understand.
So many ways to reduce CT that your readers will no doubt point out. Business owners can put in larger amounts into their SIPP now than their business. So it is easy for many people to arrange their affairs to limit their taxable income to £50k, and I see more doing this.
Similarly for non doms, more analysis came out this week suggesting that the total income will reduce rather than increase as the very rich move away and have clever people to arrange their affairs.
One of the big underlying issues than Cameron didn’t get a grip on public expenditure – an increasing head count in the public sector as that’s not why drives growth, it is the private sector.
And the stubbornness on the NHS doesn’t help, not accepting that it hugely underperforms on almost every measure, and whenever the ides of a part insurance model is raised it causes meltdown.
It may not matter too much to Labour anyway, as it’s horrific start in government in blatant extreme upturns I suspect they will be a 1 term majority, and perhaps lucky to be minority after the next GE.
Bottom line, for 25 years we have been spending too much, and it’s all coming back to roost now.