Theresa May’s gamble of calling an unnecessary early election failed.

Theresa May

Instead of increasing her parliamentary majority, she saw it collapse. As I write this, her government is limping on, but without a majority or a deal with a minor party to keep her going.

Instead May is running a minority government, with only 317 out of 650 MPs in the House of Commons. Theoretically, the government could be outvoted, but only if all the opposition parties join together to vote it down; May will be hoping that they will not manage to agree on anything for long enough to do that.

Political drama

The result was nothing like the polls and pundits were expecting, and, like the Trump and Brexit votes, it was one of those rare nights of political drama.

It was also a remarkably close-run thing. Just 146 votes spread across five seats would have given the Conservatives a practical majority; some local campaign managers must be kicking themselves, if other people are not doing it for them.

Alternatively, in the opposite direction, losing another 76 votes could have cost the Conservatives another two seats and probably left them unable to limp on as a minority government, because they would then have needed one of the smaller parties to actually vote with them rather than just abstain.

Tax policy?

But we are where we are; the Conservative government is wounded but still clinging on to office. What does this mean for the U.K.’s future tax policy, and particularly for offshore matters?

I am not going to compare May to what might have happened under a Corbyn Labour government; although Corbyn did far better than anyone expected, Labour still only have 262 MPs out of 650, 64 short of a majority. Even if they had won a few more seats, they would still have needed a formal coalition with smaller parties to form a government, so there is no telling what compromise policies would have emerged.

No, the more important comparison is how the new Conservative government, without a reliable majority, will be different to the previous one or the more stable one we were expecting. What has changed in the last few weeks?

No new chancellor

The first change is that there is no change in the man who controls the government’s finances. A week before the election, it was strongly expected that a confident Theresa May would, once she won a large majority, sack Philip Hammond as chancellor of the Exchequer, but in the current uncertain situation she is playing safe and keeping most of the main players where they were.

Hammond, contrary to his image of being boring but safe, had already made mistakes; his attempt to increase social security charges for the self-employed, despite the government’s promise of no increases in the major taxes, was widely denounced as an attempt to wriggle out of an election commitment on a technicality.

Nor was that his first offense. Hammond had previously increased taxes on individuals receiving company dividends, despite the overwhelming evidence that higher taxes on investment returns are one of the most damaging to the economy. This will affect investors and many small business owners who operate through private companies.

What’s more, like his attempted self-employed tax hike, the increase in taxes on dividends was done in a complex technical manner that seemed designed to make it too obscure to attract criticism.

Anti-business rhetoric

Unfortunately, that means that Hammond’s rhetoric against “tax avoidance,” and taxpayers’ professional advisers, will probably continue.

In his last budget, Hammond boasted that “since 2010, we have secured £140 billion in additional tax revenue by taking robust action to tackle avoidance, evasion, and non-compliance.” That’s an average of an extra £20 billion a year squeezed from businesses and investors, by tightening up the U.K.’s tax net to the point that it is becoming internationally unattractive.

Hammond also threatened professional advisers with “a tough new financial penalty for professionals who enable a tax avoidance arrangement that is later defeated by HMRC.”
That is a shocking attack on the rule of law and the ability of citizens to seek independent legal advice. Can we imagine criminal defense lawyers being fined because their clients were found guilty? The civil rights campaigners would be in uproar if anything like this were proposed in any other field of law, yet in tax there seems to be an idea that we should have to pay not just what the law requires but whatever the government demands.

Hammond has proposed some tax reductions and seems to have some sound basic ideas, but on this point he has “gone native” and sided with his civil servants against business and investors. One result of this is that we should expect more “anti-haven” tax measures to be announced, making it more difficult for taxpayers to use offshore centres, and more proposals to end financial privacy in the name of “transparency.”

The drive for cash

One problem that will only increase is the government’s need for money.

The Conservative – Liberal Democrat coalition that took over from Labour in 2010, and the majority Conservative government from 2015, have both completely failed to get control of the public finances. Despite seven years of supposed “austerity,” government spending has gone up every year and the proposed date for balancing the budget has been pushed out again and again. It is now delayed until 2025, and noone really expects them to meet even that remote target, especially as it is safely after the next election.

This failure to control spending puts pressure on the tax system, especially when interest rates start to rise and the previous governments’ gluttony of borrowing reveals its true cost.

The annoying thing is that the Conservatives seem to understand this problem, but just won’t do anything about it. Their 2017 manifesto promises a “strong economy built on sound public finances, low taxes, better regulation and free trade deals with markets around the world,” and says that “firms and households cannot plan ahead if the government’s thirst for their cash threatens higher taxes.”

That is true, but it is precisely what their over-spending is doing – creating a “thirst for cash” in the government, which is driving up the demands for tax revenues.

Unfortunately, with the government rightly unwilling to raise tax rates, that means extra tax revenues have to come from squeezing the current tax system tighter, with more attacks on supposed “tax avoidance” and more assaults on offshore finance centres with more efficient tax regimes.

The Singapore of Europe

I have written here before about Hammond’s threat to the European Union that, if we did not get a suitable deal on continues access to European markets after Brexit, the U.K. would have to become the “Singapore of Europe,” to compete on tax.

As I said at the time, being a low-tax free-trading economy should be our objective anyway, not just a threat, but at least Hammond is thinking along the right lines and recognizes the benefits of such a move.

The problem is that being a successful global trading economy is not just about tax rates but also about the attitudes of the government, and particularly the tax authority, towards businesses and investors. As shown above, that is where Hammond seems to miss the point.

What might have been?

Although we could have worse than Hammond, some of the rumored replacements might have been better.

One being touted as a possible post-election successor was Sajid Javid, son of a Pakistan-born bus driver and former vice-president of Chase Manhattan.

Javid is firmly on the free-market wing of the Conservative party, a robust right-winger who made a name for himself as a junior minister by hanging a portrait of Margaret Thatcher on his office wall, and who has already held two of the junior Treasury posts.

Javid has real experience of the financial world, including having worked in Singapore, and would have made an interesting chancellor. With him, the “Singapore of Europe” might have been a successful reality.

However, with the government in such a precarious position, May is doing nothing to rock the boat and so Hammond stays.

International agreements

What of the U.K.’s approach to international tax matters?

I have written elsewhere about the need for the government to move away from the OECD’s anti-business agenda and improve its relationships with the offshore finance centers in its overseas territories and Crown dependencies. The U.K. needs to improve its global trading and investment to make a success of Brexit, and its connections with some of the most successful offshore finance centers could play a valuable role in that.

I did have hopes that a strengthened Brexit Britain and Trump’s USA could have worked together to stop the worst of the OECD’s BEPS project, particularly its assault on intellectual property.

Unfortunately, a weakened government, desperate for money and unwilling to cause trouble, and with Hammond at the Treasury giving in to the tax collectors’ demands for more powers, I cannot see that happening under the current regime. The opportunity to strengthen Britain’s international position has been lost.

Worse, the Conservatives’ 2017 election manifesto threatened “a more proactive approach to transparency and misuse of trusts,” which presumably means compulsory registers and an end to financial privacy, either unilaterally or as part of further OECD or other international initiatives. Those offshore centers with constitutional links to the U.K. will be under pressure to follow whatever bad example the U.K. sets on this.

Although, of course, a Corbyn Labour government would have been worse, I expect the attacks on global business and investment to continue.

Brexit

Although the loss of the Conservatives’ majority has undoubtedly changed some things, Brexit is still going ahead. And it will be a proper Brexit; the government is very clear that it wants the ability to negotiate its own international trade agreements with the rest of the world, which means leaving the Customs Union.

One big tax advantage of Brexit is that the U.K. will escape the oncoming disaster of the Common Consolidated Corporate Tax Base (CCCTB), the European Commission’s attempt to abolish tax competition within the European Union and eventually bring about tax harmonization across Europe.

CCCTB is the proposal to calculate a single profit figure for the whole of a multinational’s operations in the European Union, and then allocate that profit to the different member countries according to a formula based on the location of customers, staff and physical assets. Note that there is no room in that formula for financing or intellectual property – those essentials of modern business are thought to be a tool of tax planning and so will be ignored.

With the U.K. leaving the EU, the CCCTB will not apply to us. However, the disadvantage for the rest of Europe is that, without our vote and voice in opposition, this (and other disastrous tax policies) are more likely to be implemented in what remains of the European Union.

Northern Ireland

One result of the Conservatives’ precarious parliamentary position is that Northern Ireland has suddenly become important in British politics. Although a full part of the U.K., a lot of government powers have been devolved to the local administration and it has its own political parties, separate from the normal mainland ones. With the government lacking an overall majority, how those small parties behave, and whether the government can do a deal with them, becomes very important.

Paradoxically, the government is indirectly helped by the seven Sinn Fein MPs, who want Northern Ireland to leave the U.K. Although they would probably support Jeremy Corbyn’s Labour party, they cannot do so because they refuse to take the oath of allegiance to the Crown and so cannot take their seats or vote in parliament.

On the other hand, ten Democratic Unionist Party (DUP) MPs, who are staunch defenders of Northern Ireland staying in the U.K., lean towards the Conservatives and are highly unlikely to support Corbyn because of his past links to the IRA. May’s government needs them to at least abstain in order for her to pass any votes, and ideally she wants their support to give her a buffer.

However, the DUP are tough negotiators, having had to work with their enemies in the devolved Northern Ireland Assembly, and they will want to be able to show clear benefits for their constituents in return for their support.

Part of their demand will be for extra government spending for Northern Ireland (which is already heavily subsidized by English taxpayers); the figure of £2 billion over the five years of this parliament is being talked about. Although that is a small price for the government to pay, with the deficit still out of control it means that the need for more tax revenues will increase yet further, and so the tax climate for business and investors will be even tougher.

Competing with Ireland

One interesting demand from the DUP is likely to be a lower corporation tax rate for Northern Ireland.

They feel that they are losing investment across the border to the independent Republic of Ireland, as Google and a host of other multinationals set up there to take advantage of its 12.5 percent corporation tax and generally business-friendly regime. Northern Ireland, being part of the U.K. and so within our tax system, finds it difficult to compete with their neighbor.

The British government had proposed to give Northern Ireland the right to reduce their corporation tax rate from 2018, but a combination of the snap election and problems in Northern Ireland’s own local government saw those plans shelved. Expect to see their reinstatement as one of the key DUP demands in exchange for their support of the government.

That will make the U.K. tax regime interesting, if overseas investors can benefit from a reduced corporation tax rate by operating via Northern Ireland.

However, the U.K. Treasury is reluctant to lose money from this, and has already warned that it will take steps to prevent “the risk of potential manipulation and abuse” of any lower Northern Ireland rate, so expect their proposal to be hedged around with limitations and restrictions.

But multinationals move to the Republic of Ireland not only because of its 12.5 percent corporate tax rate but also because of its wider business-friendly tax regime. Like the U.K. trying to make itself more international post-Brexit, its success depends on how you tax and what you tax, and the behavior of the tax authorities, not just the headline rate. So to compete with the Republic of Ireland, Northern Ireland will need control of more than just the tax rate.

How attractive the Northern Ireland regime becomes to outside investors will depend partly on the DUP’s negotiations with the Conservative Party over the next few weeks.

Getting worse?

Things are clearly not as bad as they might have been, but they are undoubtedly going to get worse than they were. The failure to control spending is going to increase the demands for more tax revenues, and with a reluctance to increase tax rates that extra money will have to be collected in disguised ways, getting tougher on businesses and investors.

That, and a nervousness about “rocking the boat” when the ship of state is so unsteady anyway, will mean there is no room for much-needed tax radicalism.

The “Singapore of Europe” a low-tax, free-market global trading company, is not going to happen any time soon. The chance of the U.K. forming more of an alliance with its overseas territories to attract international capital is diminishing. Instead the U.K. will stick to the tried and failed methods of more assaults on taxpayers, both unilaterally and through the OECD and similar international initiatives.

That, of course, assumes that May survives. If she is replaced by another Conservative leader, there is a possibility of a more business-friendly, expansionist government. Currently, the party seem too nervous to risk the upheaval of a change, but after the last twelve months who knows what the future will bring?

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Richard Teather
Richard acts as a tax policy consultant, including advising the Jersey parliament on their recent tax reforms, is a Fellow of the Adam Smith Institute. and is an editor or member of the editorial board of various journals. His book, "The Benefits of Tax Competition", is published by the London-based Institute for Economic Affairs. His work has been the subject of a debate in the UK Parliament and quoted in government studies in the UK, EU and Australia, and hit the national press when the UK government tried to suppress its own civil servants favourable comments on it.Richard TeatherSenior Lecturer Tax LawBournemouth UniversityChristchurch House C206Poole, BH12 5BBUKT: 01202 961870E: rteather@bournemouth.ac.ukW: bournemouth.ac.uk   

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