Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 40 - 59)

TUESDAY 4 MAY 1999

PROFESSOR MICHAEL DEVEREUX, MR EDWARD TROUP and MR GILES CLARKE

  40.  What I am really asking Professor Devereux is that he suggested in his evidence that there was evidence that tax on capital had not been affected because corporation tax receipts had remained stable. What I am saying is that it is not sufficient just to measure whether or not it remained stable. You would also need to look at whether or not as a proportion of total tax receipts, however we might define tax on capital and labour, they had remained at a similar proportion.
  (Professor Devereux)  What I am quoting is actually corporation tax receipts as a proportion of national income, GDP. There are lots of problems about defining capital taxes. The European Commission were claiming that taxes on capital had gone down. Part of the problem here is in what they included in that kind of measure. Some things, like inheritance tax, are irrelevant to this inquiry. All I was doing here was looking at a particular kind of tax which might be relevant to this inquiry and looking at what happened to that. I am not saying something about the revenue itself as a proportion of income. Taxes on labour—I could not tell you off the top of my head. I do not have any numbers for that.

  41.  But that would be the key issue, would it not, whether or not the proportion had changed for capital and had not changed for labour?
  (Professor Devereux)  Not necessarily. There is a distinction between what are called the formal incidence and the effective incidence. Corporation tax formally is a tax on the company or the shareholders as the owners of the capital. But they are not the people who are necessarily worse off as a result of the tax because they pass on that tax in terms of higher prices to the consumers or in terms of lower wages to the labour force. It is quite possible that introducing a tax does not make the owners worse off at all. It actually makes somebody else worse off because they can pass it on. In an open economy you might expect that to happen quite a lot because investors have lots of investment opportunities open to them. If they invest some money in one particular country they want to get a post tax return from that country similar to what they can earn elsewhere. If there is a high tax for investing in that country they will just either invest less or they will not invest there at all. They will require a higher pre-tax rate of return. In the process of doing that there will be less investment going into that country, and in any case it is going to be passed on to the residents of that country, the labour force, the immobile labour force. Whatever has happened about the statutory tax receipts—what is allocated to corporation tax or income tax or any variant of those—it is actually not telling you very much about who is worse off as a result of the tax anyway.

  42.  Can I just say that I referred to it because you referred to it.
  (Professor Devereux)  Sure; thanks.
  (Mr Clarke)  If you are talking about tax loss, Professor Devereux has addressed it from an economic perspective. If you are talking about loss to the United Kingdom tax base resulting from offshore jurisdictions, I think there will be a fairly general consensus that recent governments and the Inland Revenue have been pretty successful in stopping the gaps in terms of the United Kingdom tax base in terms of personal tax and in terms of corporate tax. I am particularly referring to tax haven activities of the kind that multinationals———

Chairman

  43.  I thought you called them offshore jurisdictions. I thought that we were not allowed to use the expression "tax haven".
  (Mr Clarke)  Absolutely. But in this particular context I am referring to multinational companies doing a tax sheltering exercise in an offshore jurisdiction. Perhaps 10 or 20 years ago there was a lot of sheltering of profits. I think now the combination of our controlled foreign company legislation, which has been increasing in strength since it was first brought in, and transfer pricing legislation, which of course has now been greatly strengthened in the last year or two, have very substantially blocked the scope for erosion of the United Kingdom tax base as a result of that sort of activity.

Mr Cousins

  44.  Have there been any harmful consequences of that?
  (Mr Clarke)  Of that new legislation?

  45.  Of that effective legislation which you have just referred to, the controlled foreign companies and the transfer pricing issue.
  (Mr Clarke)  I suppose in———

  46.  If it takes a tax lawyer that long to give an answer, I guess the answer is no.
  (Mr Clarke)  It is because partly you are asking a tax lawyer almost an economic question which he does not know the answer to. What I was fishing for is yes, I think I would say that there have been some harmful consequences, not least in the compliance area where, if you bring in quite complicated anti-avoidance legislation which is designed to catch particular problems and particular abuses, however well and carefully drafted it is, it inevitably brings a whole lot of other contexts and situations potentially within its ambit and involves a lot of people in a lot of compliance. That is why I was hesitating a bit.

  47.  Is that because the legislation has become more effective people have started to do things which are illegal?
  (Mr Clarke)  No, that is not what I am was saying. To take transfer pricing specifically for a moment, until recently it only operated if the Inland Revenue gave a direction. Now you have to comply with it in filing your tax returns, which does potentially significantly increase the compliance burden, that is, the cost to taxpayers of getting their tax returns right.

Dr Cable

  48.  I think we have been grappling on this side a little bit with the problems of definition. Maybe if I can state my own definition before I start you will know what I am asking about. I am making a distinction between direct foreign investment, which is effectively business taxation, corporation tax, where you have made some useful and interesting answers that I would like to pursue, and portfolio investment. There are quite separate questions, are there not, in relation to what I would call portfolio investment, taxation on savings, taxation on financial flows, as opposed to direct investment. Is that a distinction which is helpful here?
  (Mr Clarke)  I think it is a helpful distinction, yes.

  49.  But it is not complex enough?
  (Mr Clarke)  Yes. Clearly Edward Troup addressed the issue of a certain area of portfolio investment and the mutual funds scenario which he was essentially driving at.

  50.  I will start with the direct foreign investment, the corporation tax issue. What I am trying to get to, as Jacqui Smith was, is how important tax competition is in this area. Maybe if I can ask a little bit about your footnote, Professor Devereux, which is I think the only example I have seen so far about how much money we are talking about, can I read back your footnote to you in language that I understand and you can tell me if I have misunderstood it? Is what you are saying here that the result of the Chancellor having cut corporation tax by a penny in the pound that instead of Britain getting $100 million worth of foreign investment in the United States, we would expect to get $101 million?
  (Professor Devereux)  Not quite. It is a very similar kind of idea. Actually it is in terms of the probability of a foreign multinational choosing to come to the United Kingdom rather than some other European country. If one supposed that before he cut the tax rate the probability of coming to the United Kingdom was 40 per cent, if he cut the tax rate by one per cent the probability would go up to 41 per cent.

  51.  But it is an extremely small response, is it not? Is it not implying that the reason why companies locate in a particular place is the proximity to the market, the raw materials, the trained labour and playing around with the corporation tax rate has a very small impact?
  (Professor Devereux)  Whether it is small or large depends on how you are looking at it. It is larger than quite a lot of other estimates of the effect, for example, on tax on the level of investment generally, but I certainly agree with you that the location of direct investment depends on a whole range of factors, of which tax is certainly not the most important.

  52.  You have helpfully given us some numbers that make sense of tax competition in direct foreign investment. I just wondered if, in relation to the financial investment, the portfolio investment, there is anything remotely comparable. I do not know whether there is any work that any of you have done on this but let us assume, for example, that tax havens did not exist. Is it possible to say, in relation to the analysis of flows, what the level of capital receipts would be in the European Union or the United Kingdom? Can we have any idea about the magnitudes involved?
  (Professor Devereux)  I do not.
  (Mr Troup)  It is possible, as I said in answer to Jacqui Smith's question, that you do not know what people will do. It is necessary if you want to launch an international investment fund or to make some multinational investment to find a neutral medium through which to do that and to make the investments. Given that there are a number of suitable locations, it is very difficult to see what would happen if there were not such locations. I do not think you can answer any questions about that. To pick up on your first point: is there a distinction between portfolio and direct investment? Clearly a distinction does exist between those two but I am not sure whether it is that relevant to this topic. What we are talking about is the taxation of capital, the way in which capital which flows round the world from the owners of the capital to the real use, the factories, the offices, the employees, at the end of the investment chain, how that is taxed. One of the problems is that we are not entirely in agreement as to how it should be taxed. The historic basis was that the owners of capital should be taxed on everything that they get from that capital, but also we have taxed owners of capital who provide capital into our jurisdiction. What is happening is that it is getting increasingly difficult to do that and there is a tension between the extent to which we can raise tax on capital provided by foreign investors and our desire to tax the return our own residents get on their capital. In a sense what have been referred to as tax havens are purely the point at which that pressure is being let out of the system, and that can occur both on direct investment and on portfolio investment, but we are just talking about how do we tax capital, how do we avoid double taxation, as Giles Clarke said. Indeed, when you look at the United Kingdom rule, which Giles Clark has also referred to, how do we make sure that we collect one lot of taxation?

  53.  Thank you for the answer, but what I am trying to do is get a little bit past the abstract debate and to pin down exactly whether we are talking about something that is seen as important or of minor importance quantitatively. I will put the question a different way. It is sometimes said that United Kingdom business taxation is lower than the normal, certainly within the European context, but I have heard other estimates that the effective rate of British business tax, taking into account all the allowances and so on, is actually rather higher. Can you cast any light on this? Where do we sit in terms of a hierarchy of effective business taxation?
  (Mr Troup)  If you look at the percentage of GDP, we are actually quite high compared to the rest of the European Union, but again it is very difficult to compare these figures. Germany, if you look at the OECD statistics, has a low percentage of GDP paid in corporation tax, but that I believe is largely a reflection of the fact that the format which German businesses use, the GmbH format, which does not count, as I understand it, as a company in the statistics; it is not entirely clear exactly where we do stand internationally. It is certainly true that we do not have many reliefs and that as a result nominal corporation tax rate is not as low as in some other jurisdictions, does not result in as low an overall burden, but equally, when you look at businesses wanting to invest overseas, they often find that they end up with unrelieved foreign tax which suggests that the foreign tax burden is overall higher than in the United Kingdom. It is very difficult to unpick it except by looking at specific examples.

Sir Peter Lloyd

  54.  This question is probably best directed to Mr Clarke. Do tax havens/offshore jurisdictions mobilise capital which would not otherwise get itself mobilised and so increase international economic activity?
  (Mr Clarke)  That sort of question I find very difficult to answer, simply because you do not know what the position would be without it, and in any event, as a single practitioner, one only has a very limited insight as to the totality of activity going on in the jurisdictions concerned. That said, perhaps I could answer it slightly differently, that in order to make international investment you want suitable ownership structures through which to do it. You may want one or more holding companies and you may want a trust behind the companies. If you are a private individual you also want a secure, stable legal framework within which to base those entities. I think it is probably the case that people from a great many parts of the world take the view that those conditions do not necessarily obtain in their home countries. A great many countries in the world do not have the same developed company law, and indeed any sort of trust law, that we are familiar with and that most of the major offshore jurisdictions are able to offer, so to the extent that the offshore jurisdictions are able to offer that kind of legal framework I think it must be right that they assist in the mobilisation of resources because they provide an appropriate framework.

  55.  What Do Mr Troup and Professor Devereux think is the likely answer to that question because I suspect nobody can actually know?
  (Mr Troup)  I do not want to be frivolous, but it is not completely different from saying does the existence of corner shops assist in the purchase of goods? These are so widespread, there is so much capital flow, and so much of that capital flow goes through these jurisdictions——if we took away all the corner shops in the United Kingdom what would people do? They would have to buy food somewhere. Is it easier because we have corner shops? Probably yes, and in a sense this is a widespread phenomenon. This is not a small corner where you can see exactly what it is doing. This is something which does assist huge quantities of money to flow from a huge diversity of sources, some legally, some illegally, into the world markets. It seems to me that it must assist. If it did not assist people would not pay for the use of those jurisdictions and those centres. My intuitive response must be yes, it does assist tremendously and it is very hard to see how, in the jurisdictions which Giles Clarke has referred to, where there might be an unstable political regime or whatever, but nevertheless there were large amounts of capital which flowed out, how that would flow out if they did not have some sort of conduit through which to move it. It is difficult to see the world without many of these jurisdictions.

Sir Peter Lloyd:  Your analogy is probably a more telling one than you intended as you made it, because there is a very real argument. People want to protect corner shops from multiples because they are particularly convenient for some people, but the growth of the multiples has increased the efficiency of the retail trade generally. I will not pursue that.

Chairman:  Thank you very much.

Sir Peter Lloyd

  56.  Not even if the Chairman would allow me to continue. Could I ask Professor Devereux this. It is an important question even if it is an irritating one, because if there is a general benefit, even if it is unquantifiable, we should be very careful about, in Mr Troup's phrase, beating up the jurisdictions.
  (Professor Devereux)  This is an interesting analogy with corner shops. In this context it seems to me that what you are really getting at is to know what is the overall level of savings and investment in the world. Is it helped that it goes through tax havens where they are relatively well treated compared with other ways in which they would be treated differently if the tax havens did not exist? Clearly I do not know what the answer to that is, but I guess that what is more likely to happen is that the allocation of those savings and investments into different forms is going to be very different if there were no tax havens. There may be less international investment.

  57.  Can I then take up that very point and ask you this. Forgetting whether it increases the quantity, is the efficiency with which that quantity of capital is used greater because of the offshore jurisdictions?
  (Professor Devereux)  I suppose yes, it would tend to be greater because of it, yes. If tax havens did not exist and so individual savers and taxpayers therefore looked for other forms of investment, there is a presumption that there would be less efficient forms of investment. If we start from the presumption that individuals are investing more efficiently to start with, if we introduce a tax system which pushes them somewhere else, they are going to be less efficient.

  58.  But the world economy is likely in your view to be less efficient if these jurisdictions disappear?
  (Professor Devereux)  I guess that is right. How one can quantify that of course is another matter.

  59.  But the general point is right?
  (Professor Devereux)  That is right, yes.

Chairman:  You are all backing that point, are you?


 
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