Examination of Witnesses (Questions 40
TUESDAY 4 MAY 1999
and MR GILES
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 labourI
could not tell you off the top of my head. I do not have any numbers
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 receiptswhat is allocated
to corporation tax or income tax or any variant of thoseit
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
43. I thought you called them offshore jurisdictions.
I thought that we were not allowed to use the expression "tax
(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.
44. Have there been any harmful consequences
(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
47. Is that because the legislation has
become more effective people have started to do things which are
(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.
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,
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
(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
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 jurisdictionsif
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
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?