23/01/17

The U.K.'s Threat to Weaponize Tax Is No Bluff.

(Bloomberg)-- The U.K. government is threatening to give its post-Brexit economy a shot in the arm by reducing corporate taxes to become a sort of "Singapore-on-Thames," a tax haven on the perimeter of the European Union. EU officials are dismissive of the idea; but they may be whistling past a graveyard.

At a rate of 20 percent, the U.K. currently ranks in the 11th lowest tax bracket in the EU, level with Finland and Estonia, lower than France or Germany but higher than Ireland, Poland and the Czech Republic.

This is what U.K. Chancellor of the Exchequer Philip Hammond said earlier this month:

“If Britain were to leave the European Union without an agreement on market access, then we could suffer from economic damage at least in the short-term. In this case, we could be forced to change our economic model and we will have to change our model to regain competitiveness. And you can be sure we will do whatever we have to do”

In July, then Chancellor George Osborne proposed cutting the corporate tax rate to less than 15 percent to prove Britain was still "open for business" after the Brexit referendum. While Hammond hasn't been that specific, "change our model" was widely read as a euphemism for a dramatic cut in corporate tax rates.

The tax threat hasn't gone down well on the Continent. Pascal Saint-Amans, the head of tax at the Organization for Economic Co-operation and Development, wrote a memo in June arguing that while becoming a "tax-haven type of economy" would be attractive for U.K. officials, "the mood of the people is certainly not about giving more benefits" to large companies. Dutch Finance Minister Jeroen Dijsselbloem is similarly dismissive of the U.K.'s chances of persuading domestic voters that reducing levies on international companies is a panacea for alleviating the economic effects of leaving the EU:

I don’t think the people who voted for Brexit meant it to end up as a multinational-friendly tax regime. Let’s not go there. I think it’s unproductive and it’s damaging and let’s get back on some realistic issues.

But Britain's corporate tax rate is already heading lower, and without a hint of dissent from the electorate. From the start of the new tax year in April, it will drop to 19 percent; from 2020, it will be 17 percent.

And it's worth remembering that in the aftermath of the June Brexit plebiscite, the British media reported that Prime Minister Theresa May had warned her EU peers that a rate of 10 percent was possible if Britain's post-EU deal wasn't favorable. So when she said last week that "no deal is better than a bad deal," it's clear that the threat of introducing the lowest tax rate in the EU is likely to feature in the negotiations.

Irish Finance Minister Michael Noonan seemed keen to discourage Britain for that kind of thinking, saying last week that with U.K. rates already so low, "there isn't that much scope for tax competition." Then again, he would say that. He presides over a tax regime that levies just 12.5 percent, the second-lowest in the EU.

Noonan said his central bank has had more than a hundred "hard inquiries" from financial firms considering relocating from the U.K. And Eoghan Murphy, Ireland's minister for financial services, said this week he's hoping to add 10,000 net new jobs to the sector, boosting total employment in the industry by almost 30 percent. London looks bound to lose some jobs to other EU countries as firms adjust to the loss of so-called passporting rights. But an even more attractive tax regime would be one way for London to persuade banks not to shift their operations without being accused of giving the finance industry special treatment.

Britain's threat is all the more credible given global trends. Corporate taxes have been on a downward trend for years all around the world. The OECD average is down to less than 25 percent from almost 28 percent in 2006. Even in Germany, the tax rate has dropped by almost 10 percentage points in the past decade to its current level a shade below 30 percent, which in turn is below the nearly 40 percent rate faced by U.S. companies, and which President Donald Trump has said he plans to reduce. The U.K. may just be ahead of the curve.

There's a risk that the EU would seek to retaliate against any British tax-cutting initiative. May warned last week that seeking revenge against the U.K. would amount to an "act of calamitous self-harm for the countries of Europe." Singapore-style rates may not deliver the economic growth May needs, but she's at least right on the politics. At a time when European electorates are increasingly conscious of the need to preserve national sovereignty, trying to stop a departing member from adjusting its fiscal policy to account for a change in economic outlook would be folly.