3.30 p.m.

I start by referring to some of the main developments of the past year. It has been a year which has been dominated by the twin evils of inflation and unemployment.

Inflation

I ask hon. and right hon. Members to cast their minds back to the time of the Budget last March, a year ago. We were then facing a problem of cost inflation which, in the minds of many, was the biggest single threat to our prosperity. Both the problem and the threat remain, but I think that my right hon. Friends and I can fairly claim some success.

As regards prices, the facts have been published, and they speak for themselves. Since last summer the rate of increase has been halved.

I am sure that the whole House will want to pay tribute to the Confederation of British Industry for its programme of price restraint and to all the companies and nationalised industries which have responded. Together with the cuts which I made in selective employment tax and purchase tax, that programme has made a major contribution in reducing the rate of inflation and in improving the climate for wage bargaining.

Taking the past year as a whole, the average level of pay settlements has fallen significantly. I have no doubt that, in part, this has been due to the slower rise in prices. In part, too, it may reflect a growing awareness of the truth—to quote one right hon. Gentleman—that "One man's wage increase is the next man's price increase"; that there is no future in an irresponsible scramble for higher pay all round if the only result is higher prices all round; and that rising costs may be just as damaging to employment prospects as falling demand.

But if it be true that we have already made considerable progress in the fight against inflation, it is true also that we still have a considerable way to go in narrowing the gap between the rate of increase of money incomes and of productivity. And, in the end, that is the only sure way that we can keep prices steady, maintain our international competitiveness and substantially improve the prospects for employment.

Output and Employment

There is universal agreement that the present high level of unemployment is on every ground—economic and social—one which no Government could tolerate. It is also generally agreed that over the past year unemployment has risen to a much greater extent than could have been expected if one had regard only to the movement of output. The upward trend in unemployment was partly the result of very slow growth in 1970 and a fall in output in the first half of 1971. But there has been an additional factor with major consequences for the level of unemployment—the so-called "shake-out" of labour which stemmed from the rapid rise in wage costs. While cost inflation is clearly one of the causes of high unemployment, I have never agreed with those who look to unemployment as the cure for inflation.

And so throughout this past year we have acted to raise the level of economic activity. The various reflationary measures which were taken resulted in a strong rise in demand in the second half of last year: between the first and second halves of last year gross domestic product is estimated to have increased by around 2½ per cent. or 5 per cent. at anannual rate. It is difficult to forecast the level of output in the first half of this year, especially in view of the dislocating effects of the coal strike, but, to give the House the underlying trend, I believe that had it not been for the coal strike the growth of output between the first halves of 1971 and 1972 would have been broadly in line with the forecast which I made last July of 4–4½ per cent.

Monetary Developments

I turn now to monetary developments. A year ago I outlined a radical and far-reaching reform of credit control and banking arrangements. The details are known. Suffice it to say, therefore, that that reform is now in full operation, and it has opened a new era in British banking.

Monetary policy in the past year has been expansionary, in line with our other policies for stimulating the economy. All terms control restrictions on hire purchase, credit sale and rental agreements were removed last July. Interest rates have declined, and there has been a strong growth of bank lending and consumer credit.

All this has been reflected in a faster growth of money supply, and the high growth of output which I intend to sustain with this Budget will entail a growth of money supply that is also high by the standards of past years, in order to ensure that adequate finance is available for the extra output. To proceed otherwise would reduce the growth of real output itself.

This reasoning is now, I think, generally accepted. It recognises the important and strong effects that monetary policy can have on the economy. But it recognises also that these effects operate through demand.

And so monetary policy will be used in the future, as it has been during the past year, as an integral part of the general management of demand. Because one of the main qualities of monetary policy is its flexibility, I do not propose to lay down numerical targets. The policy will be geared to the needs of the situation, and will change as those needs change.

Government finance

It has been traditional to give, in the Budget Speech itself, some description of the Government's financial accounts, both past and prospective. But as all the figures are set out in the greatest possible detail in the Financial Statement and Budget Report, I think that hon. Members will agree that I can this year spare the House an oral summary.

National savings

In last year's Budget I announced a number of improvements concerning National Savings. I do not propose any further changes at this time.

Over the past year National Savings have gone from strength to strength. In the 12 months to the end of February the amount of National Savings outstanding, including accrued interest, increased by £733 million, or about 8½ per cent. That is the best result ever recorded, and it reflects great credit on the whole National Savings movement. The thousands of voluntary workers throughout the country deserve our gratitude.

I turn next to the external developments which have taken place over the past year.

International monetary matters

For the international monetary system 1971 was certainly a critical year. Strains had already been apparent for some time, and the crunch came with President Nixon's announcement on 15th August—a date I well remember because it was the very day I was due to start my family holiday! After a succession of meetings of the Group of Ten, the agreement which we reached in Washington in December produced a realignment of currencies and the removal of the United States surcharge and related measures. That realignment should in time lead to an adequate turn-round in the United States balance of payments, which is a necessary element in restoring stability in international payments. It is bound to take time to work through, as in the case of any exchange rate change.

But that is only one part of the problem. There are other fundamental questions which as yet remain unsolved. The House will, I know, appreciate the point that the United States authorities have not a sufficient stock of reserve assets at present to restore general convertibility of United States dollars held by monetary authorities. But it certainly ought to be possible to work out acceptable arrangements to enable International Monetary Fund operations to be restored to a more normal basis.

This affects in particular our own remaining I.M.F. debt, which now stands at £405 million, and which begins to fall due in June. Our reserves are now ample to repay it, and, as my right hon. Friend the Prime Minister has said, we want to repay it. Indeed, I should like to go further and repurchase also the £83 million of other sterling held by the I.M.F. This would fully reconstitute our so-called I.M.F. gold tranche, giving us £292 million automatically available for drawing from the I.M.F. in case of need as part of our reserves. It is indeed a strange world when we are frustrated in our determination to wipe the slate clean of our debts. I hope a solution will soon be found.

My own belief is that a return to a system in which all the major currencies are fully convertible depends on achieving a consensus internationally about the lines on which the international monetary system should be reformed. The crisis last year demonstrated clearly enough that reform is needed. I outlined my own view of the principles on which that reform should be based in my speech at the last I.M.F. annual meeting. The task now is to persuade some others that in the months ahead serious international discussions should take place in a constructive spirit.

Meanwhile in Europe I have been having discussions about the progress of the enlarged Community towards economic and monetary union. The steps which are proposed are fully compatible with—and, indeed, complement—the objectives of world monetary reform to which I have just referred.

United Kingdom balance of payments

The details of the United Kingdom balance of payments last year were published only a fortnight ago. So I can be brief. We had record surpluses, both on visible and on invisible account, resulting in a current surplus of £952 million. Our official reserves more than doubled.

Balance of Payments

So much for the past year. I turn now to the future, starting with the prospects for the balance of payments over the next year. It is likely that world trade will grow rather faster in the year ahead than in 1971. Expansionary measures have now been introduced in a number of countries, and, of course, the removal of the United States surcharge and related measures will also help.

The current account is expected to continue to show a satisfactory surplus, but it will not be as large as it was in 1971, which in this respect was clearly an exceptional year. Earnings on invisibles should keep up well, but I expect the balance on visible trade to be less favourable this year. The monthly visible trade figures are bound to show a deficit from time to time, because there will be a faster growth of imports as our domestic economy expands. It is as well to remember that 1971 was only the ninth year since the end of the eighteenth century in which we have had a surplus on visible trade. There is no reason to expect that it will now continue year in year out. But a modest deficit on visible trade will be no trouble so long as the other important component of the current account, earnings on invisibles, continues to keep up well—as I believe it will.

Exchange Control

I must next give the House the outcome of a review of our policies governing international investment. I have decided on the following changes.

First, the financing from sterling sources of inward direct investment. As from tomorrow, permission will normally be given for subsidiaries of foreign companies making new direct investments in the assisted areas to draw finance without restriction from sterling sources; and for subsidiaries of E.E.C. companies the restrictions on finance from sterling sources will be completely withdrawn in respect of direct investments in any part of the United Kingdom.

Second, outward direct investment in E.E.C. countries. As from tomorrow, United Kingdom companies making direct investments in E.E.C. countries will be allowed, as an alternative to the usual overseas borrowing, to use official exchange or its equivalent for the first £1 million of any project in an E.E.C. country, or in one of the acceding countries.

Finally, it is customary in the Budget Statement to refer to the so-called voluntary programme under which since 1966 companies and institutions have been asked to observe certain restraints on their investment in developed countries of the sterling area. It is right that I should pay tribute to those who have co-operated to maintain the programme over the past six years. But my right hon. Friends and I have always found distasteful the concept of this programme operated on a voluntary basis year after year. Accordingly, the voluntary programme is now abolished.

Full details of these changes are being given in a Treasury Press notice and Bank of England exchange control notices issued tonight.

I know that other relaxations have also been suggested, but I cannot go further this year. These particular changes have been selected with due regard both to prudence and to a right sense of priorities.

The Domestic Economy

I turn now to the prospects for the domestic economy.

I should at this stage stress that the analysis I am about to give of our economic prospects assumes no changes of policy. It is, of course, this analysis which provides the basis for my Budget judgment and for any proposals for change.

Looking ahead over the next 12 months or so, I would expect a recovery in private investment, both in manufacturing industry and in the service sectors. On present policies, however, I do not believe that this recovery would be of the magnitude required either to meet the challenge of Europe or to provide an adequate basis for a return to full employment.

On present policies, there are three main elements of demand where a slowing down during the year ahead seems probable—public investment, stock build- ing, and private consumption. I deal with each of these in turn.

First, public investment. As the House knows, because of the high level of unemployment we have deliberately given a large, temporary boost to public investment: and as this comes to an end the rate of increase—albeit from a high level—is bound to slow down.

Next, stock building. Stock building was abnormally low last year. A recovery to a more normal rate is almost certain at some stage, though it has probably been delayed somewhat by the coal strike. While the recovery is taking place it will give an important stimulus to the growth of demand, but this stimulus will cease when stock building settles down again at a new, higher rate.

Finally, private consumption. This has grown rapidly over the past year, stimulated by taxation reductions, by the abolition of hire purchase terms control and by a large increase in social security benefits last autumn. This rapid rise in private consumption reflected a raising of consumers' expenditure from a lower to a higher level. But it is right to expect that when this process has been completed the rate of increase of private consumption will slow down again to a more normal rate unless steps are taken to stimulate it further.

In addition, account has to be taken of what is sometimes called "fiscal drag"—the fact that as personal incomes rise tax burdens tend to increase more than proportionately. It is true that a modest boost will be given to consumers' expenditure over the coming months by the repayment of post-war credits, but this again will be a temporary stimulus.

For these and other reasons I should expect that, on the basis of present policies, the growth of output would slow down significantly during the year ahead, and would go on slowing down thereafter. The implications of such a slowing down in the growth of output for the general prosperity of the nation and for the level of unemployment in particular are obvious. Such a situation would not be acceptable.

The Budget Judgment

I have therefore come to the conclusion that a further boost to demand is required.

In weighing up how great this should be, I have had to take account of a number of considerations—the Government's determination to reduce the level of unemployment, the dangers of inflation, the outlook for the balance of payments, and the paramount need to avoid a purely ephemeral spurt which before long led to another stop. Our task at this time is to lay the foundations for sustained growth over a prolonged period ahead.

Taking into account these various considerations, I have come to the conclusion that the stimulus to demand will have to be sufficient, taking account of both direct and indirect effects, to raise output in the first half of next year by about 2 per cent.

The measures I shall put to the House are intended to ensure a growth of output at an annual rate of 5 per cent. between the second half of last year and the first half of next. I have chosen as my base period the second half of last year because a much firmer estimate can be made of the level of output in that period than in the current half year, especially in view of the uncertain effects of the coal strike.

This growth rate of 5 per cent. is a "central forecast", and I stress that because of the many uncertainties to which, as every former Chancellor knows, such predictions are necessarily subject. This is the reason why policies must be flexible, and why the only sensible course is to be ready to act at any time of the year, as indeed I did last year.

If my present expectations are correct, output will have risen by 10 per cent. over the two-year period from the first half of 1971 to the first half of 1973. The extent to which there will be a reduction in unemployment is bound to depend on our success in slowing down inflation. If particular groups insist on pricing themselves out of jobs and the nation out of business no Government can secure full employment.

I do not believe that a stimulus to demand of the order I propose will be inimical to the fight against inflation. On the contrary, the business community has repeatedly said that the increase in productivity and profitability resulting from a faster growth of output is one of the most effective means of restraining price increases.

We now have a rare opportunity to secure a sustained and a faster rate of economic expansion over a considerable period of years. I will list five compelling reasons why this is so.

First, our entry into the Common Market next January provides us with a new opportunity for faster growth, which was the experience of nearly all the existing members of the Community when they joined together to establish the larger Market.

Second, we are starting from a position where there are more unused resources than there were at the beginning of any previous period of rapid expansion since the war.

Third, our potential growth of productivity is greater than it was on any of those earlier occasions.

Fourth, the growth of public expenditure, which is deliberately being accelerated very substantially during the coming financial year, will thereafter, as we have planned, show a marked deceleration. One of the purposes of this is to leave room for expansion in the private sector.

Fifth, both the current balance of payments and our reserves position are much stronger than they were at the beginning of previous periods of expansion. Moreover I am sure that all hon. Members in this House will agree that the lesson of the international balance of payments upsets of the last few years is that it is neither necessary nor desirable to distort domestic economies to an unacceptable extent in order to maintain unrealistic exchange rates, whether they are too high or too low. Certainly, in the modern world I do not believe that there is any need for this country, or any other, to be frustrated on this score in its determination to sustain sound economic growth and to reduce unemployment. But we should not delude ourselves. There can be no soft options if we fail to get a grip on ever-rising costs.

These are the principal reasons why I believe we can now realistically look forward to a prolonged period of sustained expansion, and indeed a prolonged period of expansion is exactly what British industry so desperately needs to provide the foundation and the confidence for ambitious and forward-looking modernisation.

For the very purpose of avoiding "stop go" and specifically in order to maintain steady growth over a period of years, there will doubtless from time to time need to be measures to regulate demand; and these may be in either direction. But the prospects for expansion and for growing prosperity over the next five years must surely be better than they have been for a very long time.

This Budget is designed to set us on that path.

At this stage I want to deal with one matter which is not strictly speaking part of the Budget proper—social security benefits. I thought it helpful in the particular circumstances of last year to refer in the Budget Statement to our intentions for the year ahead, and I do so again this year for this reason.

In our Election Manifesto we promised to review retirement pensions every two years to ensure that they at least maintain their purchasing power. We have, in fact, done better than we promised. As the House knows, the Government recently decided that in future the main social security benefits will be up rated every year and that the next prating will be this autumn. This, of course, is something that pensioners have been asking for for years.

My right hon. Friend will be making a statement about this tomorrow. But, as the House found convenient last year, I will today give an outline of the Government's proposals.

Last autumn the retirement pension was increased by 20 per cent. This autumn—the first time for 20 years that there have been increases only a year apart—the pension will be increased by a further 12½ per cent. The standard pension for a married couple will, therefore, be increased by £1·20 from the present rate of £9·70 to £10·90. The standard rate for a single person will be increased by 75p, from £6 to £6·75. Other national insurance benefits and war pensions will be correspondingly improved. The basic scale rates of supplementary benefit will go up by the same cash amounts as pensions.

This means that in cash terms pensions and benefits will have been raised by about one-third above the level at which they stood before last year's increase. The two increases together, in conjunction with the assurance of an increase every year in future, will go further to improve the position of pensioners than any previous measures in the history of national insurance.

The cost of the improvements in national insurance benefits is estimated at nearly £400 million in a full year. This, of course, leads me to the consequent increase in contributions.

Once again we have concluded that the fairest way of financing the increase is by moving towards the long-term contributions structure described in the While Paper "Strategy for Pensions". This year, however, we intend to go further in this direction than last year by transferring some of the burden from employees to employers. Accordingly, the employers' flat-rate contributions will go up by 10p for men.

The earnings ceiling for graduated contributions will be raised from £42 to £48 a week. Only a relatively small proportion of the total cost will then need to be found in other ways. We have decided to meet it by an increase in the rate of graduated contributions on earnings between £18 and £48 a week; these will go up from 4·35 to 4·75 per cent. for employers and employees alike. The ordinary flat-rate contribution by employees will remain unchanged, although there will, of course, be flat-rate increases for the self-employed and non-employed.

The Exchequer will, as in the past, contribute about 18 per cent. of the total contribution income.

The pre-Budget forecasts, to which I have referred, took into account the increases in both pensions and contributions.

There is one taxation aspect I must mention. Because the Inland Revenue is so heavily committed to work in preparation for the unification of personal taxation, and it cannot this year undertake any extra P.A.Y.E. recoding work, the increase in national insurance pensions and war widows' pensions payable in 1972–73—and I had better stress only the increase, and only in 1972–73—will be tax-free.

I come now to a group of proposals designed to help British industry to expand and modernise and to improve its efficiency.

In last year's Budget speech I announced my intention to reform the structure of corporation tax in order to remove the present discrimination between retained and distributed profits. I explained that this discrimination distorts the capital market, tends to misallocate scarce investment resources, impedes companies that need to raise equity capital, and lessens the pressure for efficiency.

In the Green Paper on the reform of corporation tax which I published last year it was stated and explained that in order to achieve our objective there were only two real alternatives, a two-rate system or an imputation system which could be very similar in substance. Those two alternative systems were fully described and I invited views about the choice.

Since then there have been important consultations with industry, commerce and the professions about the alternative systems. These have been invaluable, and I think the House will agree that they have fully justified the decision not to introduce legislation until those who would be mainly affected by it had been consulted.

In addition, the choice set out in the Green Paper has been considered by the Select Committee under the distinguished chairmanship of my hon. Friend, the Member for Walsall, South (Sir H. d'Avigdor-Goldsmid), and we now have the benefit of its views. That Select Committee, like the Green Paper itself, was a new departure, although it was one which put into practice the view often expressed by those of us on this side of the House, that major tax changes should so far as possible be preceded by full and careful public consultation. The Select Committee completed its task with thoroughness and speed, and the whole House will agree that its report fully justified the innovation.

I should tell the House, frankly, that last year when I announced the proposal to reform corporation tax I had a preference on domestic grounds for the two-rate system.

Having said that, the fact is that the majority of those with whom we consulted clearly favoured an imputation system. So did the Select Committee, by a unanimous recommendation.

I have, therefore, reconsidered the matter in the light of this advice, and have come to the conclusion that the advantages of the two-rate system are not sufficient to outweigh the arguments that have been put forward in favour of the alternative. I therefore accept and endorse the Select Committee's main conclusion that the form of corporation tax to be introduced in this country ought to follow the imputation system set out in the Green Paper, and this is what I propose. The legislation will be in this year's Finance Bill, and the new tax will come into effect as from April next year.

I should add that in the course of the year I have been keeping closely in touch with developments in the community, which is engaged in a programme to harmonise the structure of its company taxation. It has not yet reached a conclusion, but the choice which we have made puts us in line with both France and Germany.

During the Budget debates my hon. Friend the Financial Secretary will be describing in greater detail the main features of the new corporation tax. I also thought that it would help the House, and those outside, if I were to publish at the same time as the Finance Bill a descriptive White Paper on the new corporation tax, and this will be done. There are, however, a number of matters on which it may be helpful for me to comment now.

International Companies

I have given a great deal of consideration to the position of those companies—and they include a small number of very important ones—which derive their profits and income wholly or mainly from overseas countries where the rate of tax is as high as, or higher than, it is here.

What these companies wanted was in substance a return to the arrangements, like those in force up to 1965, where the excess of a company's overseas tax on its profits over the United Kingdom tax on those profits could be used to reduce the income tax on the shareholder's dividend. I made it clear in the Green Paper that this was not an alternative which the Government would favour, and I am sure, with the benefit of a further year for reflection, that that decision was right.

In reaching this conclusion I am, once again, reinforced in my view by the Select Committee. The Select Committee did not, of course, formally consider the possibility of a return to pre-1965 arrangements; it was choosing between the two systems which the Green Paper had indicated as the real alternatives. But it gave a great deal of consideration to the problem of companies trading mainly in countries abroad with high tax rates; indeed, the Committee took more evidence on this point than on any other.

Its views were clear and again unanimous. It said, first, that

"…it is hard to see why double taxation relief should be so extended as to allow a United Kingdom based company not only to pay no Corporation Tax, but also to pay its shareholders net dividends on which no standard rate income tax has, in fact, been paid";

and, second, it said

"…your Committee on balance…plump for the imputation system with a minimum Corporation Tax charge as an essential element".

In addition to conforming with the unanimous view of the Select Committee on this point, there is another compelling reason for my decision. It is this: To give the overseas companies the relief they want would cost the Exchequer something of the order of £100 million a year, equivalent to increasing the rate of corporation tax for the generality of companies by 2·5 percentage points. The alternative would have been to have recouped the lost revenue from the general body of taxpayers.

It is right, too, to note that for most companies trading overseas, relief for overseas tax under the new system will, in fact, be more favourable than at present. Furthermore, none will be worse off, not even the companies whose only profits are earned in high-rate countries abroad.

Indeed, what these companies fear is not that they will be worse off, for they will not. What they are apprehensive about is that they will not be able to benefit as much under the new system as companies which have at least enough United Kingdom income to cover their dividends. And so they fear that their access to new capital for expansion and development may be impaired.

I believe that these fears are exaggerated; I recognise, however, that they are very real to the companies concerned. I recognise, too, that these companies play a most important part in the economic life of the nation. It is for these reasons that I have decided that, although I cannot meet their case in full, it would be right to give them some further relief for a transitional period. The present overspill payments will, therefore, be continued at their 1971–72 level for the period up to the end of 1976–77; by then we should be in a position to judge whether the companies' fears have, in fact, been realised.

For the purpose of this transitional relief I propose to leave the overspill rules unchanged with the single exception, logical under the new system, that as from 1972–73 increases in dividends will no longer diminish entitlement to overspill. This extension of transitional relief will cost £12 million in 1972–73 and £25 million for each of the four following years.

Rate

It is right that I should refer to the rate of the new tax. Because the tax will not become operative until April, 1973,it will not begin to be paid for the most part until 1st January, 1975. The normal practice, therefore, will be for the rate to be fixed in the 1974 Budget, and it will need to be determined in the light of the circumstances at that time.

This is two years ahead, and for the moment I can do no more than base what I say on the 50 per cent. rate which was taken for the purposes of illustration in the Green Paper. But I must stress that this is purely illustrative and that the actual rate cannot be fixed at this moment of time. I can, however, give the rate of advance payment as this is determined by the basic rate of income tax of 30 per cent. The advance payment of corporation tax will, therefore, be 3/7ths of the dividend paid.

Relief for Small Companies and Special Cases

I now turn to a matter of great importance—the situation of small companies under the new corporation tax. Both the Bolton Committee and the Select Committee rightly drew attention to the position of small companies which have to rely on their retained profits for a very large part of the funds they need for expansion and development. These small companies comprise a sector which is of crucial importance to the economy, and they must have every reasonable incentive to expand and develop.

I therefore propose that all companies whose profits for corporation tax purposes do not exceed £15,000 in any year will pay tax on their income at a special rate; with the illustrative rate of 50 per cent. the special rate for small companies would be 40 per cent., but I must stress again that these figures are illustrative. Notwithstanding the reduced rate of tax, any dividends paid will be treated as entitling the shareholder to full imputation credit in the usual way. There will be marginal relief for companies whose profits are between £15,000 and £25,000.

To give some idea of the significance of these provisions, I should tell the House that the full relief will be available to about 350,000 companies, which is more than 90 per cent. of all companies, and the marginal relief to a further 10,000 to 15,000. The cost will be substantial—on the basis of the figures I have taken £45 million in a full year—but well worth the encouragement which this will give to small companies.

My hon. Friend the Financial Secretary will be giving details of the way in which we propose to deal with building societies and co-operative societies, and also with certain unincorporated associations and other bodies of a broadly non-profit-making kind which have objects of a public nature.

Close Companies

I turn next to the taxation of close companies. To safeguard the Revenue there must be, and indeed there have been ever since 1922, special rules applicable to this type of company. But the 1965 legislation, when the name "close company" was coined, greatly multiplied the rules, and these have been a constant source of complaint. There can be no doubt that in recent years the rules which the Inland Revenue was bound to apply have been unduly harsh and unnecessarily burdensome.

The first point to remember is that the only justification for special rules for close companies is to prevent avoidance of tax; there is no other justification. Accordingly, my starting point is that we should retain legislation of this sort only to the extent that significant sums of revenue are at stake.

The House will recall that we said in last year's Green Paper on the reform of corporation tax that one of the objectives was to secure a major simplification of the close company rules.

One important simplification which the new system of corporation tax itself enables us to achieve is this: a shortfall assessment will in future be confined to the income tax at higher rates and the investment income surcharge. But it is right that the simplification of the system should go well beyond this. Following the relief which I gave to trading companies last year, the starting point for shortfall will again be raised. This will be done in three ways which will be explained by my hon. Friend.

All these reliefs will take effect from next year when the new corporation tax comes into force. To give the House some idea of the practical significance and extent of these changes, the result can be expressed in this way. Last year's reliefs took out of shortfall over half the trading companies which at that time were within its scope; next year's raising of the threshold will effectively take out about half of those which remain. So the combined effect of the two Budgets will be to relieve altogether from shortfall some 80 per cent. of the trading companies that came within its scope in 1970 and previous years. This represents a very considerable easing of the work burden which for far too long has lain on the backs both of companies and their advisers and of the Inland Revenue.

In total, these changes and others which will be in the Finance Bill will amount to a very substantial simplification of the close company legislation. In future it will be strictly confined in scope, easier to understand and a good deal less difficult to administer.

Capital Gains of Companies—General

I come now to the treatment of capital gains of companies, and I deal first with companies in general. The Green Paper recognised that it would not be appropriate for the rate of tax on companies' capital gains to rise in line with the increase in the rate of tax on retained profits. It therefore envisaged that the overall rate of tax on gains might be reduced by the expedient, which is administratively simple, of leaving part of each gain out of account but charging the remainder at the full corporation tax rate.

This approach was endorsed by the Select Committee, and I propose to follow it. The fraction of the gains to be left out of account will be fixed at the same time as the new corporation tax rate. If I were fixing it now, I should proceed on the basis that the effective rate of tax on companies' gains should be 30 per cent.

Capital gains of companies—Unit and investment trusts

I turn next to a matter which has been the subject of a great deal of discussion in this House in recent years—the special case of approved unit and investment trusts. Ever since 1965 the trusts have contended that they should themselves be exempt from capital gains tax. For reasons which I shall explain, I do not believe that this is the appropriate solution. Having said that, I agree that the present tax treatment of unit and investment trusts is clearly both inequitable and complex. Despite the cost, it is right that the necessary changes should be made, and they will be included in this year's Finance Bill.

The guiding principle must be that the tax on capital gains should be neutral in its impact on the ability of a trust to act as a medium of investment. The present arrangements are obviously not neutral, for the 30 per cent. rate of tax on trusts' gains may be higher than the rate which the person of modest means would have to pay if he invested on his own behalf. Equally, the arrangements for avoiding the double taxation of gains, first when they are realised by the trust and then again when they are reflected in the value of units or shares, are so cumbersome in practice that they may themselves deter investors.

So the law must be changed. But it would be a departure from neutrality simply to exempt the trusts in full, for that would give them the benefit of tax-free switching and would put them at an advantage compared with other investment media, and, indeed, with the ordinary individual managing his own portfolio.

As from April this year there will, therefore, be a new system under which gains realised by trusts will be taxable at the rate of 15 per cent. When the shareholder disposes of his ordinary shares or units, he, too, will be taxable, but in calculating the tax he has to pay he will be given a tax credit of 15 per cent. of the amount of his gain. This credit, which will not be repayable, will effectively take into account the 15 per cent. charge borne by the trusts.

The House will recall that most individuals do not pay capital gains tax at the full 30 per cent. rate on their gains; instead, they pay at their personal income tax rate on only half their gains up to £5,000 if this is more favourable. Under the new unified system next year, for those of them who are liable only at this basic income tax rate of 30 per cent., that will mean an effective capital gains tax rate of 15 per cent.

This in the case of units or investment trust shares will be wholly offset by the 15 per cent. credit on account of tax paid by the trust. The result will be that no individual on the basic rate of income tax will then have to pay any tax at all when he disposes of his units or investment trust shares; the trust will have settled the bill for him.

The new system will be much easier to understand and will certainly enhance the attractiveness of unit and investment trusts. The long-term cost will be about £30 million a year, although in the early years it may be somewhat higher than this.

Share Option and Incentive Schemes

Next, the matter of share option and incentive schemes.

In 1966 the Finance Act charged to income tax all gains from share options given by a company to its employees or directors. That legislation, as was no doubt intended, effectively put a stop to share option schemes. But, as the House knows, there has since grown up a variety of share incentives schemes under which gains to participants are liable only to capital gains tax.

I believe it is now recognised on both sides of the House that the 1966 legislation was altogether too drastic and that, contrary to the view which was then put forward by Treasury Ministers, share options have a proper and valuable rôle to play in stimulating management enterprise and in helping industry to recruit and to keep the management talent that it needs.

The Finance Bill will, therefore, contain provisions under which share option schemes which are approved by the Inland Revenue as meeting prescribed conditions will be exempted from the 1966 legislation. Gains from other schemes will continue to be charged to income tax, and so in future will gains from share incentive schemes which do not meet similar conditions. The conditions will be broadly similar to those which responsible bodies regard as necessary to safeguard shareholders' interests.

Free Depreciation

The country now stands at a moment of great challenge but also of tremendous opportunity. If we are to take full advantage of the enlarged Community market which will be opening up for us in less than a year, one of our foremost tasks must be to improve our competitiveness as a trading nation.

The hard fact is that for years now the level of productive investment in this country has been low by comparison with that of our main trade competitors. For example, in 1970 Japan invested no less than 28 per cent, of her national income. The average figure for the Six was 19 per cent. In this country it was 15 per cent.

The primary factors which determine the level of productive investment are two-fold—business confidence in a sustained growth of demand, and profitability.

A major part of our strategy must, therefore, be to provide the climate in which industry can have the confidence to re-equip and expand.

For very many years the leaders of British industry have called upon successive Governments to introduce nationwide free depreciation for all investment in plant and machinery. The problem is, of course, that to do this would remove the present taxation differential between the country in general and the development areas, where, the House will recall, I introduced free depreciation in October, 1970.

The other request which has repeatedly been made by industry is for investment incentives which are stable and easy to understand. With the opportunities which are opening up for this country, the time has now come to provide these incentives.

As from tomorrow, free depreciation—that is to say, a 100 per cent. first-year allowance—will be introduced throughout the whole country for all investment in plant and machinery, other than passenger cars, whether the investment lakes place in a development area or not.

For the sake of simplicity free depreciation will apply equally to investment in new and secondhand equipment. In other words, as from tomorrow the whole country will enjoy the taxation treatment previously reserved for the development areas.

For industrial buildings the rate of initial allowance for new buildings outside the assisted areas, which was due to revert to 15 per cent. on 6th April this year, will be increased to 40 per cent. This means that the 40 per cent. rate of initial allowance for new buildings will apply throughout the country. Again, in this respect also as from tomorrow the whole country will enjoy the taxation treatment previously reserved for the development areas. The cost of all these changes will be £5 million in 1972–73 and £115 million in 1973–74.

There will be no change in the rate of corporation tax for the financial year 1971.

Regional Policy

It will, of course, be immediately apparent that by introducing countrywide free depreciation I have removed altogether the existing taxation differential in favour of investment in assisted areas. It is our purpose, however, not merely to re-establish the regional differentials but to do so in the framework of an entirely new approach to regional policy which will give the development areas a more clear-cut preference than any previous system.

The new system of regional incentives will be simpler, more easily understood and more certain in its application than the existing arrangements. Businessmen will be able to evaluate more readily the advantages to both their firms and the country of providing more job opportunities in the assisted regions. My right hon. Friend the Secretary of State for Trade and Industry will be describing the Government's proposals in greater detail tomorrow, but the House will wish to know the main proposals now.

The existing arrangements for helping the development and intermediate areas rely heavily on the powers under the Local Employment Act to make grants of various kinds, in particular with regard to the building grants which are available throughout these areas on condition that the projects provide an appropriate amount of employment. The Government now propose, as a central feature in the renewed attack on the problems of the older industrial areas, to make building grants much more widely available. In respect of new industrial buildings started from tomorrow in the assisted areas there will be a new system of regional development grants which will not be subject to the employment condition and which will also be available, for example, for schemes which safeguard existing employment and for straightforward modernisation. The scope of these grants will be described in greater detail tomorrow by my right hon. Friend, but I should say now that they will apply to a wide range of industries in the assisted areas without their having to go through the procedures at present required under the Local Employment Act. This will speed up and also simplify the administration of the scheme.

The rate of grant for buildings in the intermediate areas and in the development areas other than the special development areas will be 20 per cent. In the special development areas it will be 22 per cent. Moreover, these grants will be on a different basis from previous grant incentives. They will not affect the recipient's entitlement to taxation relief on his investment; he will still be able to claim capital allowances on the full amount of his investment notwithstanding that part of it has been covered by grant. The separation of grants and tax allowances in this way will not only make for simpler administration; it will also make it very much easier for the businessman to see the precise margin of advantage to him if he invests in an assisted area. The value of the new grants will be substantially enhanced by the new tax basis. For a company making profits a grant of 22 per cent. is equivalent, on the old tax basis, to a grant of over 30 per cent.

Geographically, the broad coverage of the development areas will be unchanged. But there will be a major extension of the intermediate areas to embrace, broadly speaking, those parts of the North-West and of Yorkshire and Humberside which are not already included, together with those parts of Wales which are at present unassisted. This will absorb into the intermediate areas a large part of what are termed the derelict land clearance areas. The remaining part of these derelict land clearance areas will, as a temporary measure, get the same 20 per cent. building grants as the intermediate areas for a period of two years, as a once-for-all fillip to industrial renovation.

Under the Local Employment Act the development areas, though not the intermediate areas, get other forms of assistance to industry. It is necessary to restore and reinforce the differential treatment of the development areas in a way which best meets their present need both for more enterprise in existing industries and for new firms and industries capable of seizing the opportunities provided by the European market. There are opportunities in these areas for foreign firms as well as British. These are powerful reasons why our incentive system needs to be simple to understand and capable of offering advantages to newcomers as well as to established firms.

The Government have, therefore, decided that in the development areas alone the grant scheme should be extended to plant and machinery on a basis closely related to the arrangements for building grants. The rate of grant for capital expenditure incurred on new plant and machinery from tomorrow will be the same as for building grants—thatis, 22 per cent. in the special development areas and 20 per cent. in the rest of the development areas—and the scheme will be on the same new tax basis.

As in the case of capital allowances, the cost of these grants will depend on the level of qualifying investment, and actual payments fluctuate a good deal. Subject to that, the estimated additional expenditure in the development and intermediate areas is approximately £200 million in the first full year.

These general schemes will be supplemented by continuing selective assistance in the areas of high unemployment on the lines of the loans and special grants hitherto provided under the Local Employment Act.

The measures which I have announced—free depreciation and new measures for the regions—together provide the most powerful combination of national and regional investment incentives which we have had in this country since the war. Moreover, in order to give industry the stability it seeks when planning long-term investments I should make it clear that the intention is that the new system of investment incentives—[Hon. Members: "Grants."]—including free depreciation, should endure at least until the end of the E.E.C. transitional period; that is, to 1st January, 1978.

The object of these measures is twofold: first, to stimulate investment and modernisation and so to help industry to equip itself to compete more effectively in the Common Market; and, second, to make a new and intensified assault on the deep-seated problem of regional imbalance, which involves so much hardship and waste of resources.

The House knows my views about the regional employment premium. The previous Administration undertook that it would continue until at least September, 1974, and that there would thereafter be no question of abrupt termination of the scheme. In our manifesto we said that we would phase out R.E.P. taking proper account of existing obligations and commitments. That will be done, and R.E.P. will accordingly be phased out over a period from September, 1974. The rate and method of phasing out will be announced in due course in the light of the circumstances at the time and after consultation with industry.

Relief for interest

I come now to the question of tax relief for interest.

During the Report stage of last year's Finance Bill, after referring to our election pledge, I explained at some length both the approach of the Government and the problems consequent on the Report of the Crow her Committee last year. The reference is the Official Report of 6th July, 1971, columns 1200–1203. I pointed out that the Government's commitment was part of a programme for a Parliament. I also made it clear that the burden on the Administration must be a major factor and that reallowance without restriction would require 1,000 extra trained staff. Nevertheless I intend to make a start this year.

For the reasons I explained last year there cannot be relief for ordinary hire-purchase transactions. That, of course has always been the position. There has never been relief in respect of ordinary hire-purchase transactions. For administrative reasons at present, and to maintain equity as between different forms of credit, the first £35 of all interest paid will not qualify for tax relief except in the case of loans for house purchase. Secondly, action will be taken to frustrate the artificial transaction of borrowing to buy dated securities with the certainty of a capital gain on realisation on or shortly before redemption. Subject to these two restrictions, relief for interest will be restored as from 6th April. The cost is estimated at £3 million in 1972–73 and £7 million in a full year.

Sale and leaseback, and deferred premiums

As was foreshadowed in announcements made last August, the Finance Bill will also contain provisions concerning the treatment of short leaseback arrangements, and of certain forms of tax avoidance involving the use of premiums for leases and other capital payments made by instalments.

Charities

In our manifesto we stated that we would encourage the flow of private funds to charities, and over the past year I have been considering how best to do this. Charities already benefit greatly from the covenant system, and I do not propose to change that. It has repeatedly been put to me that there should be some relief from estate duty on bequests to charities and I agree. Unfortunately, because of the opportunities for manipulation by a few if very large sums were to be exempted, there must be a limit. Subject to that, it is right to act.

I have, therefore, decided that after today any property going to charities will be exempt from estate duty up to a maximum of £50,000. There are certain bodies concerned with the preservation of the national heritage where I am satisfied that there need be no limit. So property going to these bodies will in future be exempt from estate duty without limit. These include the National Trust, the National Gallery, and the British Museum.

There is one further and important way in which I propose to help charities. This proposal also is the outcome of representations and discussions over the past year. After today all gifts made to charities or to those other bodies I have just referred to will be exempt altogether from capital gains tax. In the case of this proposal the exemption will be without limit.

I have no doubt, from what I have been told, that these two proposals will be of very considerable benefit to the charitable and other organisations concerned. The estimated cost is £7 million in 1972–73 and £15 million in a full year.

I turn now to the value-added tax. The House will recall that a year ago I announced a major reform of indirect taxation under which a value-added tax would be introduced in April, 1973, and, at the same time, purchase tax and S.E.T. would be abolished. A Green Paper was published as a basis for consultation with trade and professional associations and other interested parties. That procedure has been widely welcomed, and the Customs and Excise Department has had separate discussions with more than 300 organisations.

This process of consultation has been invaluable in planning the details of the tax with the object of ensuring that from the point of view of industry and commerce it will be at least as simple to operate as in any of the eight European countries which now have a V.A.T., and much simpler than in most of those countries. Our objective has been not merely to design a V.A.T. but to design the best possible form of V.A.T. There can be no doubt that the Green Paper procedure and the consultations which have followed have paid handsome dividends.

Last November I announced that I would publish the value-added tax legislation during the Budget debate instead of waiting for the publication of the Finance Bill as a whole. A draft of the relevant Clauses and Schedules will be available in the Vote Office when I sit down. This draft legislation forms an Appendix to a White Paper in which is set out an explanation of the main features of the tax. This will be a help both to the House, I hope, and to those outside. In the course of the Budget debates, my hon. Friend the Minister of State will be giving details of the tax. This afternoon I must of necessity concentrate on those aspects which are of wide general interest.

Tax-paid Stocks

Before I come to the tax itself, I deal with one particular aspect of the transition from purchase tax to V.A.T. which is both difficult and important—the treatment of stocks which will have borne purchase tax and which, being still unsold when V.A.T. begins, will then attract V.A.T. The problem of purchase tax paid stocks has been with us on a number of occasions over the years. It was not a problem for the previous Administration because it arises only when purchase tax is reduced. No satisfactory solution has hitherto been found. But the fact remains that if no relief were given many retailers and others holding stocks of purchase tax paid goods would seek to protect themselves by running down their stocks. Moreover, some retailers might increase their prices in order to recover both the purchase tax and V.A.T. on their goods.

This is a very difficult problem of transition, and I have considered a number of ways of dealing with it. In fact there is no perfect solution. It would be wholly impracticable to attempt an accurate stocktaking on 1st April of every one of the half million businesses concerned and then seek to estimate the purchase tax they had paid. What is wanted is a formula which is simple, which involves the minimum of additional work at a time when everyone will be occupied immediately before V.A.T. becomes operative with the preparations for V.A.T., and which yet gives traders a reasonable measure of relief. After consulting a number of those concerned, the problem will be tackled in two ways.

First, those dealing in readily identifiable goods will be able to use sale or return arrangements, so that if the goods are still unsold when V.A.T. comes into operation there will be no liability to purchase tax. Most cars and many consumer durables are, in fact, already sold under these arrangements, which work well.

For other goods purchase tax will end a short time before V.A.T. is introduced, so that in preparation for it retailers will have an opportunity to build up stocks which have not borne purchase tax.

Details of these proposals are given in the White Paper, and there will be further consultations with trade interests. This scheme will have the advantage of benefiting the cash flow of traders. Similar problems will arise in respect of stocks of goods subject to the Revenue duties if those duties are reduced to avoid increases in the total level of taxation of the goods concerned when V.A.T. comes into operation. The extent to which I can make such reductions must take account of economic circumstances nearer the time. I propose, however, to take a power, to be used only before the introduction of V.A.T., to make appropriate reductions in the Revenue duties by order.

Small Traders Exemption

Before I turn to the rate structure of the V.A.T., there is one general exemption I should mention. Most countries which operate a V.A.T. provide some means of excluding small businesses. Having examined the different methods, I have come to the conclusion that the best way is to provide for a general exemption governed by turnover.

In determining the limit, there are two considerations: the loss of revenue, and the need to ensure equity as between small and larger businesses in competition with each other. In those countries whore turnover is the criterion, the highest limit for exemption is £1,450. Bearing in mind, however, the need to keep the administration of the new tax simple, I have decided that there will be a general exemption for all businesses whose taxable turnover—including zero-rated items—does not exceed £5,000 per annum. This will exclude from the tax about half a million traders.

Rate structure and coverage

I now turn to the structure of the tax—both the rate structure and the coverage. In those countries which operate a V.A.T., the number of rates varies widely. I am referring to the number of positive tax rates, not including the zero-rate.

Most countries have several rates. For instance, France and Belgium have as many as four rates. Others have only one rate. It is self-evident that the fewer the different rates the easier the tax is to administer, the easier the tax is for the business community to operate, and the fairer and less distorting the tax is.

I am convinced that this is right. I have, therefore, decided that there will be only one uniform rate of value-added tax. What this rate should be I will return to shortly when I have described the coverage of the tax.

There is one area to which special considerations apply. Motor cars represent a major source of revenue from purchase tax—at present more than £300 million a year. To forgo a substantial proportion of this revenue would inevitably mean a significant increase in the rate of V.A.T. on all other goods and services. There will therefore be, in addition to the V.A.T., a separate tax on new and imported cars of 10 per cent. of the wholesale value, which will come into force at the same time as the V.A.T. The House should know that these two taxes on cars will together yield considerably less than the present 30 per cent. purchase tax on cars, and this reduction in yield should be reflected in car prices.

The Finance Bill will include a regulator power to change the V.A.T. rate between Budgets for the purposes of economic management, and this will, of course, apply to V.A.T. generally, including cars. I have, however, decided that the new car tax will not be subject to a regulator power.

Main exempted and zero-rated categories

I turn now to certain cases which I think the House will agree justify special relief.

All countries with a value-added tax have provision for a variety of reliefs. But there cannot be too many special cases or one of the main points of the new tax would be lost.

Before describing them I would remind the House of the difference between exemption from value-added tax and zero-rating. In broad terms, a firm which supplies zero-rated goods or services gets complete relief from value-added tax both on its purchases and on its sales. One which is exempt is completely outside the tax; it does not have to charge tax on its sales but it cannot reclaim the tax on its purchases.

As is the case in all European countries with a V.A.T., there will be exemption for a variety of financial services, including insurance. There will also be exemption for postal services, for education and health services, and for certain other areas details of which are set out in the White Paper.

As far as charities are concerned, value-added tax will apply only to taxable activities undertaken by way of business. So only those few charities which supply taxable goods or services exceeding £5,000 per annum will, in fact, be subject to tax. The vast majority of charitable activities will, therefore, be outside the tax, and the overall effect on their costs of the changes in indirect taxation, taking into account the abolition of purchase tax and S.E.T., is likely to be very small. When account is taken of the proposals I have already put to the House on the direct tax side, it is clear that charities will be substantial net beneficiaries from this Budget.

I come next to the main areas where relief will be given by zero-rating. First, food.

In our election manifesto we promised that V.A.T.

"would not apply to food, except for those few items already subject to purchase tax."

This undertaking will be honoured. Food, other than those foods now subject to purchase tax, will be zero-rated. Those items at present liable to purchase tax are estimated to yield about £150 million in the coming financial year, and if they were to be relieved altogether from V.A.T. there would have to be a commensurate increase in the rate of V.A.T. They will, therefore, be charged at the standard rate. The overall effect of these proposals, together with the abolition of S.E.T., will be a reduction in the burden of tax on food.

In the last Budget I said that newspapers, periodicals and books would be relieved of the tax. These, too, will be zero-rated. In the case of newspapers, zero-rating will apply not only to sales but also to advertising. This is right because there are special circumstances attaching to newspaper advertising, in particular the large volume of advertising by private persons. The relief will not apply to other advertising media.

Advertising on television, for example, will be undertaken almost exclusively by registered traders who will be able to reclaim the tax on this advertising under the ordinary accounting procedures of the tax.

In our election manifesto we also said that under a value-added tax

"Special arrangements would be made for housing".

The details again are set out in the White Paper, but in broad terms what they amount to is that all new construction, whether of houses or of other buildings, will be zero-rated, while other transactions in land and buildings will be exempt. This means that new housing will be wholly relieved from V.A.T. What is more, it will also be relieved from the S.E.T. which is now a significant addition to housing costs. In addition, all rents will be exempt and there will be full relief for local authority rates.

Exports of goods will, of course, be zero-rated, as well as certain other items mostly connected with exports. One of the arguments which has been repeatedly put forward against a single rate tax is that there should be a special lower rate—as there is in some other countries—for such essentials as fuel—gas, electricity, coal—and passenger fares. I did consider these representations carefully but, as I have told the House, my conclusion was against a special lower rate for these items. But fuel and fares, like food and houses, are of special importance to poorer people, and I have, therefore, decided that they shall have the most favourable treatment, and be zero-rated.

Rate

I now turn to the question of the rate at which V.A.T. will be charged when it is introduced in a year's time. As with all future rates of taxation, a final decision can only be taken in the light of the economic situation at the time.

But I am sure that it is right, in order to help industry and commerce with its forward planning, that I should state now the rate which I have in mind. Indeed, I think it is right to go further and to provide for that rate in this year's Finance Bill. In order to allow for the needs of economic management at the time when the tax comes into operation, the legislation will also include a once-for-all power to substitute by Treasury Order, before 1st April, 1973, a rate within a range of 2½ percentage points on either side of the prescribed rate. In other countries with a V.A.T. there is a wide range of standard rates, from the lowest figure of 10 per cent. in Luxembourg up to the highest, 23 per cent. in France. The rate prescribed in the Finance Bill will be 10 per cent. The House should know that, even taking into account the special arrangements for cars, the yield will be less than the comparable yield of purchase tax and S.E.T. at current rates.

To sum up. The particular value-added tax designed for the United Kingdom will be at least as simple to operate as in any of the countries which now have a V.A.T., and much simpler than in most of those countries. What is more, no country in Europe has a lower standard rate than the one I propose.

Over the past years there has been much talk about the relative effects of the change to V.A.T. on different levels of family income. In particular, it has been suggested that the change from purchase tax, with its high rates on so-called luxury goods and low rates on so-called essentials, to a single rate of V.A.T. might bear more heavily on the poor than on the rich. Yet in practice these definitions of luxuries and essentials devised in the main 30 years ago have little relevance today. It makes no sense that, for example, television sets, electric, gas or paraffin heaters are taxed at 30 per cent., while items such as Persian carpets or the latest Paris fashions should be taxed at a mere 11¼ per cent. And I am sure hon. Members opposite will be hard put to explain why, to take two pertinent examples, boats should be exempt from purchase tax while pipes are taxed at 45 per cent.!

The V.A.T. I have outlined has been deliberately designed with the interests of low income families in mind. Food and housing will be relieved of the tax, and these are, of course, very important items in the budgets of lower income families. S.E.T., which at present enters into the cost of both food and housing, will go. If I had stopped there, it would have been open to question whether the change would be regressive. But I am going much further. Fares and domestic fuel and light will also all be zero-rated. The decision on fuel is almost as important in this respect as the decision on food, because fuel like food takes up a significantly larger proportion of the budgets of low income families, including, of course, pensioners, than of those who are better off. There is, therefore, no reason to fear that the change-over to V.A.T. will be regressive.

Purchase Tax

I have said that the stimulus to demand needed in this Budget should be sufficient to raise output in the first half of next year by about 2 per cent. As one means to this end—and to help to keep down prices—I have decided to take some further action on purchase tax now, and to do so in a form which will smooth the transition to V.A.T. From midnight tonight the 45 per cent. rate and the 30 per cent. rate of purchase tax will both come down to 25 per cent. The cost will be £135 million in 1972–73.

These changes, together with the cuts of last July, go a long way to reverse the successive increases in purchase tax made under the previous Administration, and I am glad to have been able to return the top rate of tax from the 55 per cent. at which it stood before last July to 25 per cent. at which it stood when my right hon. Friend the Home Secretary was Chancellor of the Exchequer in 1964.

These changes will be widely welcome in bringing an immediate reduction in prices.

This is a further step in the gradual two-year process of abolishing purchase tax and S.E.T. and moving to a V.A.T. In fact, the total overall effect of the whole process of the reform of indirect taxation starting from the time of my announcement in the last Budget and moving to a V.A.T. of 10 per cent. will be to reduce taxes on expenditure and so help to keep down the cost of living.

Green Paper

I turn now to estate duty. As the House knows, a number of threads run consistently through the taxation reforms on which we are engaged—the need to restore incentives, the need to encourage savings, and the need to create conditions in which men and women can, by their efforts, contribute effectively not only to their own well-being but to the prosperity of the country. Last year I announced major reforms of personal income tax, of corporation tax, and of the whole system of indirect taxation.

On the first we legislated last year, and, as I have already said, the second and third will be covered in this year's Finance Bill. The House will be relieved to know that I do not propose that this year's Bill should also provide for the complete reform of the system of taxation of capital on death.

But the time has now come when we should begin to consider whether the estate duty, which has been with us for about 80 years, is in fact the right means of taxing capital on death. Other countries have evolved systems which are fundamentally different from ours. Is it right that, in general, as under the existing system, the amount of duty should be calculated by reference to the value of the whole of the deceased's estate, without regard to its distribution?

May there not be a case for calculating the duty by reference to those who inherit the property rather than by reference to the deceased? Is there not also an argument for scales of duty which vary according to the relationship of an inheritor to the deceased? Is it right that the same rates of duty should be payable in respect of a bequest to a son or a daughter as to a stranger? In other words, while the system of estate duty undoubtedly has considerable advantages, we should consider whether an inheritance tax might not be fairer.

It would be quite wrong to take such a fundamental decision without the fullest public discussion. Over the past year we have been making a thorough review of the complex issues which are involved and of the implications of replacing estate duty by an inheritance tax. The outcome of that review is today being published in a comprehensive Green Paper. It deliberately reaches no conclusion. All I ask is that the whole subject should be considered afresh without preconceived ideas.

Changes

Because full public discussion of a possible reform is bound to take some time, it would be wrong to leave matters where they are. The burden of estate duty has been made much heavier over the years by the fall in the value of money. The present estate duty scale, which broadly speaking dates from 1949, and which was regarded as pretty severe when imposed by Sir Stafford Cripps, has become more and more severe in its incidence as the years have gone by.

I have already told the House of my proposals for relief from estate duty on property going to charities.

There is one particular aspect of estate duty which has been raised on a number of occasions during the past year. It has been suggested that the matrimonial home should be exempt from estate duty. I have considered this proposal carefully, but I cannot agree, because to provide this relief would be very unfair as between the widow whose husband owned his house and the widow whose husband chose to rent it. But, having said that, I have no doubt that there should be special relief for the widow, and that the fairest way to achieve this is to make the relief general.

I have, therefore, decided that in future any property going from a husband to his widow, up to a sum of £15,000, will be left out of account altogether for estate duty purposes. This relief will apply equally to property left by a wife to her husband.

Secondly, I propose to raise again the threshold below which no estate duty is payable. It will be increased from £12,500 to £15,000.

Taking these two reliefs together, the effect, for example, will be that where the estate is left wholly to the widow no duty will be paid at all unless the estate exceeds £30,000 and thereafter the estate duty will fall only on the excess over that sum, and will, of course, start at the lowest rate.

Thirdly, I propose to take action to ease the burden of the duty, which has been increasing because of the fall in the value of money since the 1949 scale was fixed. So far as the smallest estates are concerned, the policy of both Governments in progressively increasing the exemption limit has protected these estates, and this form of relief has to some extent extended to estates immediately above the exemption limit. I have carried this process a step further today.

So far as estates above this range are concerned I would have liked in principle to have gone all the way back-to the 1949 scale re-expressed in real terms—that is, adjusted to take account of the fall in the value of money. I cannot go as far as this, but there will be a completely new scale. This new scale, which appears in the Financial Statement, while giving a measure of relief, still remains generally more severe in real terms than the 1949 scale. It reaches a top rate of 75 per cent. on property over £500,000. I might mention that if I had continued the scale to a top rate of 80 per cent. at, say, £1 million, it would have added to the yield only an extra £500,000.

The relief for the surviving widow—or widower—will cost £60 million in a full year and £30 million in 1972–73. The increase in the threshold and the reduction in the rates will cost £68 million in a full year and £34 million in 1972–73. The relief for charities will cost £15 million in a full year and £7 million in 1972–73. These are big figures, but more than two-thirds of the total cost represents the relief for the widow, for charities and the increase in the threshold. The reduction in rates accounts for less than a third of the cost. While it represents a real measure of relief, as I have already said it leaves the scale generally higher in real terms than it was in 1949, and by international standards our death duty charge is still exceptionally heavy.

These changes will relieve from duty 40 per cent. of estates which would otherwise have been liable, and with the changes I made last year this means that altogether 50 per cent. of estates which would otherwise have been liable to duty will have been wholly relieved—all of them at the lower end of the scale.

All these proposals will take effect in relation to deaths occurring after today.

Tax-Credit System

Before I come to my final proposals I must refer to one other important area of long-term reform. Last year I announced that we were carrying out a study into ways of simplifying the whole structure of the P.A.Y.E. system, in particular the possibility of introducing a non-cumulative system. As we promised, we have also during the past year been considering the implications of a negative income tax.

The future of P.A.Y.E. is, of course, mainly a question of the mechanics of tax collection. A negative income tax raises much wider questions of the whole approach to social payments and the relief of poverty. Yet it soon became apparent that in practice the two studies were closely linked.

The present P.A.Y.E. system is well established: it is fair and it is respected. The unification of income tax and surtax and the ending of the complicated earned income relief will make it easier to understand and to operate. Yet certain well-known disadvantages will still remain. The process of annual coding is complex and time-consuming, and it is difficult for the man in the street to understand. Even after unification the P.A.Y.E. system will require the employment of some 35,000 in the Inland Revenue and perhaps as many again in industry.

As the House knows, while we have been searching for a simpler system I decided that the Inland Revenue computerisation programme should be suspended. I am well aware of the disruption and disappointment that that decision caused. Yet I am sure that it would have been a great mistake to go on with a vast new mechanisation programme only to have to make radical changes, possibly before it was completed.

In Britain we have two systems existing side by side—a taxation system which embodies a set of reliefs and allowances based on one set of principles, and a social security system which embodies a different set of benefits and allowances based on a different set of principles. Each has been amended and added to again and again over the years. It is obvious that immense difficulties are involved in trying to bring these two separate systems together in a simpler and more general system.

But there can be few in this House who have not at some time or other been attracted to the idea of some form of negative income tax. The theoretical attraction of such a scheme, as hon. Members will know, is that there should be a single assessment of income which would suffice either for calculating the tax due if the income is above a certain level or for calculating the social benefit to be paid if it is below that level. Such a scheme would provide a fairer and more accurate method of directing help to many people in need, and it would tidy up the present borderline between taxation and social benefits. It would provide a smoother graduation from the area of benefit to that of taxation, and so it would avoid some of the worst features of what has become known as "poverty surtax", with all that that implies by way of disincentive to earn more.

One of the difficulties of making progress hitherto has been that no really detailed scheme, which took account of all the complications of our two systems of taxation and social security, and which could reasonably be regarded as practicable and acceptable, has been put forward as a basis for discussion.

Last year a comprehensive and detailed scheme was worked out by Mr. Cockfield, my special adviser on taxation, it was a new tax-credit system combining many of the features both of a form of negative income tax and of a radical simplification of P.A.Y.E. After consider-in gthis, my right hon. Friend the Secretary of State for Social Services and I decided to set up a working group of senior officials—some full time on this particular project—to examine the new scheme. Their studies have confirmed our own belief that this new system is both practicable and desirable.

Because this is a development of such immense importance, and a development which is, I believe, in principle acceptable to hon. Members in all parts of the House, it seems to me to be eminently suitable for examination by an all-party Select Committee of this House. I therefore propose to publish later in the year a Green Paper setting out the scheme in detail. I hope that the House will in due course agree that it should be referred to a Select Committee for study and report.

It is essential that there should be plenty of time for full public discussion, but I would expect that if such a scheme found general acceptability we should be able to legislate during the course of this Parliament. The preparatory work before such a massive change could actually come into operation would, of course, take longer.

I must ask the House to await the publication of the Green Paper later in the year, but hon. and right hon. Members will be interested in the following salient features of the tax-credit system.

It would cover about 90 per cent. of the population. For these people all the main personal tax allowances—the single, married and child allowances—would be abolished and replaced by a simple system of credits which would be payable whether or not the recipient was a taxpayer. Credits would normally be set off against tax payable, but where the credit was greater than the tax the difference would be paid as an addition to the wage or other income.

Family allowances and all the complications of the claw-back would likewise go and be superseded by a child credit. In almost all cases credits would also supersede the family income supplement

The National Insurance Scheme, reconstructed as proposed in the White Paper "Strategy for Pensions", would continue, as would the supplementary benefit scheme. But the number of people who would need to draw supplementary benefit would be substantially reduced.

The P.A.Y.E. system would be reduced by a system embodying a simple non-cumulative tax deduction at the basic rate of 30 per cent., with supplementary deductions for the small proportion of taxpayers liable at the higher rates of tax.

Under the present system there are 450 P.A.Y.E. codes which have to be operated by nearly a million employers. All this would disappear completely. The task of the employer would be made easier, and the system would be far simpler for the taxpayer to understand. For the great majority of taxpayers there would be no year-end assessment.

The scheme, as well as applying generally to those who are in employment and come within the national insurance scheme, would also cover retirement and other national insurance pensioners and those who receive short-term national insurance benefits. The credits would continue to be paid during unemployment and sickness and, as a corollary, the corresponding benefits would be brought within the tax net as was originally provided when the present national insurance scheme was introduced by the post-war Labour Government. As the House will recall, their subsequent exclusion from tax rested solely on administrative grounds which will disappear under the new system.

Finally, the scheme would save some 10,000 to 15,000 civil servants.

If this scheme commends itself to the House, it would provide a substantial and comprehensive benefit to lower-paid workers and to a very large number of retirement pensioners. It would provide this benefit without individual means-testing, but the benefit would, in essence, be selective because its value would fall progressively as income increased.

This new system represents the most radical reform, improvement and simplification of the P.A.Y.E. and social service systems for a quarter of a century. Not only that, but it would also mean a considerable improvement in the position of very many people in the more hard-pressed sections of the community. I commend it to the House.

Unified tax

Last year we legislated for the new unified system of direct personal taxation, which will become operative in April next year. The Finance Act, 1971, provisionally fixed the basic rate of tax and the level of personal allowances which would apply under the new system. I explained, however, why I could not then—two years ahead—settle the higher rates of tax and the details of the surcharge on investment incomes. But I was pressed from both sides of the House to give some indication before the Budget of 1973.

I agree that in such an important change as we are making the people who will be affected should know broadly where they stand. Moreover, many large concerns these days use computers to calculate their employees' pay and tax. If the higher rates of tax were not to be announced until this time next year, they would be faced with some difficult problems in amending their computer programmes. All the rates of tax which next year will operate under the unified system will, therefore, be provisionally fixed this year.

The House will recall that the present complicated dual system of income tax and surtax will be abolished and will be replaced by the higher rates of income tax. The schedule of these rates is set out in the Resolution which will be circulated shortly. But I can summarise the proposals in this way. On the first £5,000 of taxable income—that is, after account has been taken of personal allowances—tax will be charged at the basic rate of 30 per cent. The rate for the slice of taxable income between £5,000 and £6,000 will be 40 percent. and the rates for successive slices above that amount will rise in steps of 5 per cent. until a maximum rate of 75 per cent. is reached at the level of £20,000. This will provide a much simpler, smoother and more easily understood scale.

I now turn to the investment income surcharge which the House will recall is to be imposed on the larger investment incomes. I have made it abundantly clear that I regard the present form of discrimination against investment income as unacceptable. Indeed, among the advanced countries of the world the United Kingdom and France are the only two which draw such a distinction to any significant degree. One of the foundations of the unified tax system is that only the larger investment incomes should attract the surcharge; in other words, that the first slice of investment income should be charged at the same rates as earned income. To fix a low starting point would undermine this principle.

I have decided, therefore, that the surcharge will be imposed only on the excess of investment income over £2,000. As well as benefiting retired people living on income from past savings, this will also be of considerable help to people such as divorced and separated wives who depend on what the income tax rules treat as investment income. The House will be interested to know that it is estimated that no less than 30 per cent. of the tax reductions arising from the new unified system will go to the 11 per cent. of taxpayers who have retired. Furthermore, the fact that from next year the first £2,000 of investment income is to be treated exactly the same as earned income will be an important encouragement to the personal saving we shall need to finance investment.

The rate of the surcharge will be 15 per cent. This will, of course, be in addition to other tax, so that a taxpayer whose income is within the basic rate band will pay in all 45 per cent. on any investment income which is liable to surcharge; that is, on that part of any investment income over £2,000.

The net cost of these changes will be £300 million in a full year.

Surtax

When the new unified system of tax is in full operation the surtax office will be run down and eventually close. This poses a transitional problem. And so to meet the very difficult staffing position before unification takes over I propose to adopt precisely the same device as the right hon. Member for Birmingham, Stechford (Mr. Roy Jenkins) adopted in his last Budget in almost identical circumstances. For the short time before surtax goes, the surtax starting point will be raised by £500, with marginal relief, but when income exceeds the new limit surtax will continue to be charged at the same rates as at present on the excess over £2,000. The result will be that, at a cost of £14 million for the full year, 130,000 taxpayers who are just within the surtax net will be taken out of charge for this year, over a third of whom have not paid surtax before. I should perhaps add that but for this change the cost of collection of the £14 million would be £1¼ million. The details of this change are in the Financial Statement and Budget Report.

I know that the whole House will join with me in congratulating the two Revenue Departments on the way in which they have tackled the programmes of reform, and I hope the House will allow me to give my personal thanks to my three outstanding Treasury colleagues.

Personal allowances

The various changes that I have so far announced would raise output in 'he first half of next year by under ½ per cent. But the House will recall that my Budget judgment was that output should be raised in that period by around 2 per cent. in order to increase our rate of economic growth to 5 per cent

I come, therefore, to my final proposal. Last year I reduced the standard rate of income tax and I made a start on raising tax thresholds by increasing all the child allowances and so raising the starting points of tax for all families with children. This year I believe a broader approach to the problem of the threshold is called for.

There will, therefore, be no change in the standard rate. Instead there will be increases in both the single person's allowance and the married allowance. This is undoubtedly the best means of helping taxpayers generally right across the board. If effect is to be given to these changes quickly and without an impossible work burden, the increases must this year be of the same amount. Otherwise it would be necessary to recode a very large number of taxpayers, and it is simply not within the capacity of the Inland Revenue to do this at this time. It has, in fact, arranged to speed up the preparation of the new tax tables so that on this occasion the reductions can be reflected in the first pay packet after 3rd May.

We on these benches believe that the British people have been taxed too heavily for too long. We have already made a start, but we must go further. The personal allowances will, therefore, be increased at a cost of £960 million in 1972–73 and £1,200 million in a full year. The single person's allowance and the married allowance will each be raised by £135. The House will not be surprised to know that these are the largest increases which have ever been made in these allowances. The single person's allowance will be raised from £325 to £460 and the married allowance from £465 to £600.

The income limits for age exemption will also be raised, to £634 for a single person and to £929 for a married couple. The limit for small income relief will be raised to £550.

The increase in the personal allowances will mean that the point at which a person starts to pay tax will be raised very considerably. For the single man and the married man without children the starting point will go up by £174 a year of £3·34 a week. If one considers the family man with children the change is even more impressive. Before last year's Budget a married man with two young children started paying tax when his earned income reached £16·15 a week. As a result of last year's increase in child allowances and this increase in the married allowance, his tax threshold will be up by £5·31, so that he will in future not start to pay tax on his earned income until it reaches £21·46 a week.

Another way of expressing this year's changes is that, while all those below the new starting points will be totally exempt from tax, everyone in the land who remains liable to income tax—and there are over 21 million of them will pay £1 a week less tax. And, of course, in the case of those married couples where the earnings of husband and wife are each over the threshold, they will pay £2 a week less tax. About 2¾ million people who would have paid tax this coming year will be freed of liability altogether.

Conclusion

The other day my right hon. Friend the Prime Minister said that the nation expected Government, employers and unions alike to act in the national interest to defeat inflation.

Over the past year the Government have made the biggest ever cuts in indirect taxation. Both public and private industry have supported the C.B.I, initiative on price restraint. Since last summer the rate of rise in prices has been halved.

Today I have announced a £1,000 million cut in income tax which will increase by £1 a week the take-home pay of every taxpayer above the new starting point.

I am the first to admit that a year ago when prices were rising much faster it was not easy for some to accept the need for moderation in pay claims. But today the situation is quite different, and I believe that the British people will now have no patience with any group whose actions endanger our hopes for prices and employment.

In total, the reductions in taxation which I have announced today amount to some £1,200 million in 1972–73, together with the other reductions which have been made since this Government came to office, the burden of taxation in this coming year will have been reduced by over £3,000 million.

To sum up, this is our purpose: to revitalise British industry so that it can open up the new frontiers of Europe; to achieve a rate of growth twice as fast as in the past decade; and to secure a growing prosperity which can be sustained into the foreseeable future and which will benefit all our people.

Motion made, and Question,

That pursuant to Section 5 of the Provisional Collection of Taxes Act 1968 provisional statutory effect shall be given to the following Motion—

Purchase Tax (Motion No. 3).—[ Mr. Barber.]

put forthwith, pursuant to Standing Order No. 94 ( Ways and Means Motions), and agreed to.

Motion made, and Question proposed.

That it is expedient to amend the law with respect to the National Debt and the public

revenue and to make further provision m connection with finance; but this resolution shall not authorise the making of—

5.38 p.m.

5.53 p.m.

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6.56 p.m.

Debate adjourned.—[ Mr. Fortescue.]

Debate to be resumed tomorrow.

Sitting suspended till Seven o'clock.