John McManus: Why the middle class will not invest

DCM Editorial Summary: This story has been independently rewritten and summarised for DCM readers to highlight key developments relevant to the region. Original reporting by Irish Times, click this post to read the original article.

One suspects Simon Harris underestimates the challenge involved in countering the middle class’s jaundiced attitude to investing.

It is understandable. The Minister for Finance was only a few years old when the wheels came off what, until that point, had been the investment vehicle of choice for any Irish person with cash to spare: the bogus non-resident account.

They were not an investment product. Neither were they government approved. But as the 1999 Public Account Committee inquiry into the abuse of the accounts made clear, a lot of blind eyes were turned to them in official and Government circles.

An estimated quarter of the taxpaying population used an overseas address to open a bank account in the 1980s and 1990s in order to avoid paying deposit interest retention tax (Dirt). When you consider interest rates were averaging more than 10 per cent in the 1980s, dodging the Dirt tax – which at one point reached 30 per cent – represented a pretty significant enhancement of your investment return.

The bogus accounts were easy to set up and operate. As the former Labour TD Pat Rabbitte memorably told the Dáil in 1998: “Apparently all one had to do was have a word with the bank manager, give him the name of a cousin in the Bronx and one need not have paid any tax.”

While technically a bank account, the bogus non-resident account did share the key feature of any investment product: risk. In this case it was the risk of the tax man eventually coming calling. Which he did at the end of the 1990s when everything came tumbling out into the open on foot of an investigation into irregularities at National Irish Bank. In the end, Revenue recovered more than a billion in unpaid Dirt and penalties, much of it through a series of amnesties. It was nice while it lasted but the hangover hurt.

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The lesson for Harris in this is that if he wants to succeed in coaxing the middle class back into the investment markets he will need to generate a bit of that bogus non-resident account energy.

Easier said than done. Whatever enthusiasm the middle class had left for low-risk investment after the bogus non-resident account clear-out was subsequently beaten out of them by the collapse in Eircom shares and the banking debacle.

Harris was only in his teens when Eircom was floated in 1999. More than 547,000 people bought shares in the State-owned telecoms company and most took a bath when they lost two-thirds of their value in the dotcom bust. The Minister was in his 20s when the Irish banking industry imploded under the weight of ill-judged property lending. AIB and Bank of Ireland were worth €50 billion at their peak, with up to 30 per cent of shares held by retail investors. The destruction of middle-class wealth was enormous.

The extent to which all of this dampened the enthusiasm of the middle class for investment products is captured somewhat elliptically in a Central Bank report on retail investor participation published in December. It refers to “periods of significant market volatility may have played a role in the development of a financial culture with relatively low levels of trust and risk appetite, which favours cash and deposits over investments”. The authors have a clear gift for understatement.

Harris seems to have based much of his thinking on how to direct into investment some of the €170 billion held on deposit in banks and financial institutions on this report. It is part of a wider EU initiative to channel savings into productive investment to deepen capital markets and drive growth.

Interestingly, the method the Central Bank recommends for coaxing us back into the fray once again has a throwback to the bogus non-resident accounts.

It references the recently published EU blueprint for savings and investment accounts for small investors, “which includes a recommendation for Member States to apply simplified and advantageous tax treatments to these accounts”. Whatever else they were, bogus non-resident accounts were certainly simple and advantageous from a taxation point of view.

The Minister has not really shown his hand yet, but the lesson from the most successful Irish middle-class investment scheme ever is clear: keep it simple. The appeal of the bogus non-resident account was their simplicity; they were easy to open, the return was attractive and you did not pay any tax.

Obviously, the idea of making the returns entirely tax-free is a hard sell and not entirely wise. The danger Harris faces when trying to design a tax-based incentive for these new vehicles is that he gets captured by the investment industry, which is far more focused on tweaking the existing system to the benefit of their current small but very wealthy and profitable client base.

When they start talking to him about “eight-year deemed disposal” and “limited loss-relief provisions”, he should take himself back to the simpler time of his boyhood.