IREF - Institut de Recherches Économiques et Fiscales
Pour la liberté économique et la concurrence fiscale
The economic outlook is extraordinarily uncertain as no-one knows how long the credit crisis will last or how much damage it will do. Blaming the credit crisis, which he referred to on 14 occasions during his speech, the Chancellor downgraded his growth forecast but stuck to the view that 2008 will be the bottom, with growth picking up from 2009. If the Chancellor is right, this is hardly the stuff of crises.
However, high inflation, weak income growth and a correcting housing market look set to depress consumer spending for an extended period – even if the credit crisis somehow evaporates magically overnight.
Mr Darling acknowledged that slower growth means higher borrowing in the short-term, but promised to meet the golden rule over the cycle by donning the hair shirt later. Unfortunately, even after five years of solid growth – as good as it’s going to get – the government is still borrowing some 3 per cent of GDP in 2008-09. So the hair shirt will ultimately have to be pretty tight.
The Chancellor took the opportunity to spend a great deal of time talking about the UK’s tax competitiveness but unfortunately, he failed to follow this up with any real action. Despite his comment that the UK has ‘the most competitive corporation tax regime in the G7’ and ‘a stable tax regime’, the fact is that since 2000, the UK’s corporate tax rate has fallen from the fourth most competitive in 2000 to around 20th in the enlarged EU - and has dropped from the eighth most competitive to 20th among OECD countries.
A KPMG survey last year, just two percent of respondents thought the UK had the most competitive tax regime. In particular, the Chancellor implied that there had at least been limited tinkering with the system. However, immediately afterwards HMRC put out 107 separate budget notes containing new rules around financing structures and the way in which UK headquartered companies’ foreign profits are taxed. Many companies will face a hike in the effective tax rate they pay on their worldwide profits as a result.
This global tax rate is much more important to multinationals than the headline corporate tax rate in any one country as it reflects the actual amount they pay.The effect of his announcement mean that being headquartered in the UK means, for many companies that their worldwide tax rate will be higher than if they were located somewhere else. Even in comparison to the US, a country with a high headline corporate tax rate, the measures arguably make the UK less competitive as a location for the world’s largest corporations.
Despite the changes announced there was no formal update to the over-arching reform process to the way in which the UK taxes profits earned overseas. It is more than a year since the process began and business has been waiting for a full consultation document. Some may take the news as a signal that the consultation document is unlikely to contain any good news for them and decide that they will not bother to wait for it. Unfortunately, the Chancellor appears deaf to the growing concern that the UK tax system is becoming less competitive.
Small and Medium businesses
Yet again the Budget contained some very mixed messages for SME’s in the UK. On the one hand he made many references to how he intends to help and develop the entrepreneurial sprit in the UK with initiatives such as the Entrepreneurs Relief, and an increase in the Small Firms Loans Scheme which has been extended to all SMEs – which is good news.
However, he failed to mention the fact that SMEs are going to be hit by a tax hike next year when their rate of corporation tax is increased by 3 per cent (from 19 per cent to 22 per cent) and didn’t address the issue of how an 18 per cent flat rate CGT will be bad news for many SMEs.
Whilst his attempts to encourage entrepreneurial business in the UK was welcomed, the Chancellor also failed to address the fact that many entrepreneurs currently in the UK are also non-doms and his failure to back down on his proposed £30,000 fee will do nothing to encourage them to build their businesses in the UK.
The government has previously stated that it wants to increase the number of small and medium-sized companies (SMEs) that will qualify for R & D tax credits but since this counts as EU state aid it is having to jump through a number of hoops in order to get approval.
The effect of some of the changes announced by the Chancellor is that contrary to his stated aim of supporting SMEs, it will be particularly difficult for struggling firms to access this valuable incentive. SMEs whose most recent accounts are not prepared on a ‘going concern’ basis will not be able to claim the R & D tax relief. For some companies this could be the difference between just surviving and finally going under.
This could potentially create tensions between businesses and their auditors. For example, the availability of an R & D tax credit might be enough to maintain the company as a going concern but until the accounts are signed as such, the credit would not be available – thus creating a circular argument.
In addition, the Chancellor’s budget has introduced a cap on the level of qualifying expenditure for any single R & D project of EUR7.5 million. Whilst this is unlikely to be a huge issue for smaller SMEs, those at the larger end of the spectrum may have to monitor their spend more carefully.
Unfortunately, where the SME sector is concerned, Chancellor failed to take hold of the opportunity to re-establish his credibility with them and could have done more to help.
The non-dom debate
Non-doms who have been in the UK for only seven years would have been pleased to hear that they may have been granted one year’s grace before the £30,000 tax charge applies – details published in the Budget last week suggest that the residency test before the charge bites is to be extended to eight out of eleven years, rather than eight out of ten. And there is also an interesting concession of sorts on the 90-day-a-year residence test, where a day is now only counted from arrival in the UK at midnight.
Overall though, non-doms’ prayers for an indefinite deferral of the changes have gone unanswered. The charge is coming in - albeit with some sweeteners on children and artworks - and some measures even apply immediately from today. The full impact on the attractiveness of the UK as a place to come to do business remains to be seen. I feel it will not be positive – and the net financial gain to the UK coffers will be relatively small.
The Chancellor announced that International Financial Reporting Standards would not be implemented in the Government’s accounts until the financial year 2009-2010. It’s important to remember that preparation is key to the successful implementation of IFRS - certainly, our experience of the introduction of IFRS into the private sector was that the companies that started the earliest fared the best.
The extra year will be important in enabling central government to prepare thoroughly and to restate the previous year’s accounts for comparative purposes. It will be important, though, that momentum is not lost and that this deferral does not result in the foot being taken off the gas in the movement towards IFRS reporting. A year is not a long time in financial reporting, and there is still very little room for slippage
Power to HMRC
HMRC confirmed on Budget Day that new legislation regarding is powers to enforce tax compliance will be included in this year’s Finance Bill, following a period of consultation which ended two weeks ago.
The key point will be whether HMRC has listened to representations made during this consultation period. For example, key business concerns include adequate rights of appeal against proposed HMRC action.
One of the more draconian proposals would be the power to make unannounced visits to business premises to inspect assets and business records. While there is an appreciation that HMRC needs adequate powers to ensure compliance, business is concerned to ensure these powers would be used proportionately with proper oversight
Good news for the oil companies ?
UK oil companies will be pleased that the Chancellor resisted the urge to increase tax rates on their profits despite very high oil prices.
But the Government has stopped the offset of investment management costs against UK oil and gas profits. In doing so the Chancellor expects to raise an additional £150m per year.
At the same time, long-life assets will now qualify for 100 per cent ‘first year’ allowances (up from 24 per cent) as will mid-field life decommissioning costs. There are further technical changes including a fairer system for tax deductions for the costs of abandoning North Sea fields and the possible opting out of fields that will not pay Petroleum Revenue Tax. Overall, these reforms increase tax overall whilst bringing some welcome relief.
Bad news for the film industry
The Chancellor’s announcement means that it will no longer be possible for individuals to offset losses from their film investments against their other income, unless they play an active part in the management of the film business. Similar legislation was introduced in last year’s budget to close down tax relief on losses incurred by partnership film businesses. The new legislation targets individuals seeking to shelter otherwise taxable income.
The UK film industry has benefited a great deal in recent years from the flow of investment through tax-driven structures. While the Chancellor’s announcement won’t come as a surprise to the industry given HMRC has made no secret of their dislike of these types of arrangement, it will undoubtedly have a negative effect on the funding of the British film industry
Bingo industry misses out on the jackpot
The budget has failed to provide a much-needed boost for Britain’s beleaguered bingo halls, as the industry had hoped that VAT would be abolished on participation charges or a reduction or abolition of bingo duty, delivering some respite for bingo companies during a difficult trading period.
In addition to being hard hit by the smoking ban, UK bingo halls have faced for several years faced ‘double taxation’ where they pay 15 percent bingo duty on gross profits, as well as VAT on their participation and session charge income of 17.5 percent - a situation not replicated across the rest of the gaming industry.
The abolition of VAT could have saved the industry almost £100 million in revenue which could have been channelled towards encouraging players back to the halls, either through reducing participation fees or increasing the prize pools. The Government has missed an opportunity to show the bingo industry it has listened to its views and recognises the value it provides, not just as a tax payer, but also as providing a valuable social role for many communities.
Despite lots of media coverage that the Chancellor would be delivering a “green budget” this year, the few announcements that he made last week will have only a marginal impact on UK carbon emissions. The Government has stated its intention to increase the UK’s carbon reduction targets from 60 per cent to 80 per cent but has it missed another opportunity to put any significant policy initiatives in place that will actually help achieve this.
The limited measures that were announced by the Chancellor will only account for a reduction in carbon emissions of around 5 per cent by 2015 at the earliest. It is still very unclear from a personal and corporate perspective how the vast majority of carbon reduction will be delivered. Considering the Chancellor’s promise back in December to put sustainability at the heart of the budget his announcements amounted to no more than minor changes, more reviews and a headline grabbing plastic bag tax in 2009.
The Chancellor announced that tax relief will now be available for businesses who choose low carbon-emitting cars, but for most businesses, the employee already enjoys tax relief when choosing fleet cars with low C02 emissions and this has had a dramatic impact on vehicles selected. For businesses who provide a limited choice of cars, it would seem sensible for them now to choose cars which give them the greatest tax benefit.
Overall, though, this change is unlikely to have as much impact on the environment as the earlier reform that linked the personal tax charge to CO2 emissions. Companies will also need to review whether they buy or lease their car fleet. Chancellor’s overall rating : not the huge debut that we were expecting. Could do better !
The Global Flat Tax Revolution : Lessons for Policy Makers
The Center for Freedom and Prosperity has released a new study in its educational series on global tax policy authored by Cato Institute Senior Fellow Dan Mitchell. The study documents the dramatic shift to single-rate tax systems, particularly in the former Soviet Bloc. There are now 24 jurisdictions with some form of flat tax, and the evidence confirms that these simple and fair tax systems are promoting faster growth and higher incomes. Moreover, thanks to tax competition, the number of nations with pro-growth tax systems is expected to grow.
Thanks largely to tax competition, governments are dramatically improving tax policy. Over the past 30 years, tax rates on productive activity have been sharply reduced. Personal and corporate income tax rates have been slashed. Capital gains tax rates, wealth taxes, and death taxes have been lowered or eliminated. These pro-growth reforms have boosted the global economy, lowered poverty, and improved living standards.
Perhaps the most exciting development, though, is the flat tax revolution. The number will probably be higher by the time you are reading this, but as this article went to press, 24 nations have adopted some form of single-rate tax regime. These reforms have generated impressive results, including faster growth, more jobs, and increased competitiveness. While politicians generally are most concerned about losing tax revenue, they should not worry. Flat tax systems oftentimes generate higher tax revenues because of more income and better compliance.
The economic consequences of tax reform are positive, but the political implications also are profound. Governments are deciding – in part because labor and capital can cross national borders to escape punitive tax rates – that it no longer makes sense to discriminate against highly-productive taxpayers. Thanks to tax competition, expect the number of flat tax countries to continue to grow.
Why Are Tax Burdens So Different in Different Developed Countries ?
January 27, 2008
There are striking differences in tax burdens across nations, as explained in a recent report by the Organisation for Economic Co-Operation and Development. Measuring the tax burden in 2006 as the percentage of gross domestic product that is collected in taxes, the report arrays 20 countries from top to bottom. At the top is Sweden, with a tax burden of 50.1 percent ; at the bottom is South Korea, with a tax burden of 26.8 percent.
The United States is near the bottom, with 28.2 percent, and between it and South Korea are Greece and Japan, each with 27.4 percent. Next below Sweden is Denmark, with 49 percent, France,with 44.5 percent, and Norway, with 43.6 percent. The middle range is illustrated by Britain with 37.4 percent, Spain with 36.7 percent, and Germany with 35.7 percent.
In all 20 countries except the Netherlands, the tax burden has increased since 1975, though in some countries, such as the United States, the increase has been slight—only 2.6 percent. In others, however—Denmark Greece, Italy, Portugal, South Korea, Spain, and Turkey—it has exceeded 10 percent. Spain’s increase has been the greatest, at 18.3 percent, followed by Italy’s at 17.3 percent and Turkey’s at 16.5 percent.
The OECD report explains that the increase in tax burden is due to increased revenues from "direct" taxes—income (including payroll) and corporate taxes—rather than from "indirect" taxes such as VAT, sales taxes, and other excise taxes. Even though most countries, including the United States, have cut income and corporate tax rates, the cuts have been more than offset by increases in income and corporate profits ; of course the cuts may have helped generate those increases. The OECD favors indirect taxes because they tax only consumption, whereas direct taxes tax income that is saved, and thus discourage investment.
The increase in the tax base for direct taxes explains the mechanism by which the tax burden has grown but not why it has grown—why in other words the demand for government spending has grown. The OECD speculates that the cause is increased demand for social services such as pensions and health care.
The curious thing about the OECD data is that prosperity, economic growth, and other measures of economic well-being do not seem closely correlated with the tax burden. The variance across countries in tax burden is very great, yet one finds troubled economies, such as those of Japan and Greece, near the bottom of the tax-burden distribution—of course Japan is a very wealthy country, as Greece is not, but Japan’s economic performance has been disappointing in recent decades. And one finds some high-performing economies, such as those of Sweden, Norway, and Finland at the top of the distribution, or (as in the case of the Netherlands, Spain, and the United Kingdom) in the middle. However, there is some negative correlation between economic performance and the tax burden ; for Ireland, Switzerland, and the United States are low on the distribution, while typically low-performing Western European countries cluster in the upper half.
One would think that the tax burden, especially but not only when it is created mainly by direct taxes, would have a strong negative effect on economic well-being. (Perhaps it does, when other factors affecting economic well-being are adjusted for, which I have not attempted to do.) If government is less efficient than private enterprise, the more economic activity that is performed by government rather than by the private sector the less productive the economy as a whole should be ; and the higher the tax burden, the greater the amount of economic activity performed by government. To the extent, moreover, that variance in tax burden across countries reflects variance in marginal rates of taxing income and corporate profits, we would expect the high tax-burden countries to be less productive, because the higher the tax on income, the greater the incentive to substitute leisure (which is untaxed) for work and to expend resources (and create economic distortions) in an effort to reduce the tax bite.
But there is an important difference between the actual production of economic goods and services by government, on the one hand, and transfer payments on the other. The effect of taxes on the behavior of the taxed entity is the same, but the effect on the efficiency of production is different. In the United Kingdom (which nevertheless has a high-performing economy), the government produces medical services ; the National Health Service is the employer of the vast majority of doctors and other health professionals and owns most of the hospitals and other health care facilities in the U.K. ; only about 8 percent of the U.K.’s population is served by private health providers. In contrast, the U.S. Medicare and Medicaid programs transfer vast amounts of public money to health care providers, but the providers are mostly private. The transfers come with strings attached, of course, and some of those strings induce inefficient behavior by the recipients. Nevertheless, a U.S. National Health Service on the English model would undoubtedly be highly inefficient compared to our admittedly highly imperfect private provision of health care. Transfer socialism is not as inefficient as means-of-production socialism.
To the extent that the growth in government spending is a growth in transfers rather than in government ownership of producers, the impact on economic growth and prosperity may be small, especially since the growth in transfers has coincided with the deregulation movement, which has resulted in privatization of significant areas of traditional public ownership, less regulation of the economy, and, as I mentioned, lower direct-tax rates. There thus appears to be a kind of balance, in which the efficiency-reducing effects of greater government spending are contained by reductions in direct-tax rates, by increased privatization and deregulation, and by channeling increased tax revenues mainly into transfer programs rather than into government production of goods and services.