Written evidence submitted by the CBI
The CBI is the UK's leading business organisation,
speaking for some 240,000 businesses that together employ around
a third of the private sector workforce. With offices across the
UK as well as representation in Brussels, Washington, Beijing
and Delhi the CBI communicates the British business voice around
the world.
1. What are the key principles which should
underlie tax policy?
The primary purpose of taxation is to raise revenue
to fund government expenditure programmes. Ultimately, different
groups will have different ideas regarding the additional purposes
of taxation. These will include redistribution and changing behaviour.
It is up to governments to decide on the appropriate
balance between these competing priorities, but, in all cases,
the objectives should be achieved as efficiently as possible.
From an aggregate welfare perspective, the ideal tax system would
be "neutral", ie would not distort decisions in areas
such as business investment and recruitment. But policy priorities
inevitably result in a non-neutral system.
Instances where the tax system works in the opposite
direction to non-tax policy objectives should be minimised. This
requires those responsible for setting tax policy to be aware
of other Government policy priorities. In the current economic
climate, it is particularly important that taxation policy is
undertaken in a way which supports, or, where possible, does not
inhibit, economic growth. This means that tax competitiveness
is also a critical principle.
2. How can tax policy best support growth?
UK TAX COMPETITIVENESS
The competitiveness of corporate taxation influences
not only the decisions of internationally mobile companies to
locate and/or remain in the UK, but also the incremental investment
choices made by international groups with operations in the UK.
As well as affecting the stability and breadth of the tax base,
multinationals tend to have higher rates of productivity and produce
positive spillover effects in the countries in which they operate.
Therefore, an uncompetitive corporate tax system can have negative
implications for both tax revenues and economic growth.
The UK's tax competitiveness has been slipping in
recent years. The Coalition Agreement published in May announced
the government's commitment to aim for the most competitive corporate
tax regime in the G20. This is necessary for ensuring a stable
and broad tax base as well as a more vibrant economy, generally.
Many elements will inform a company's view of whether a country's
tax system is competitive.
All taxes create distortions through their effect
on prices. Prices are used by producers to set the most profitable
level of production and by consumers to maximise their utility.
Taxes disrupt these signals by driving a wedge between the price
paid by the buyer and the price received by the seller. The taxation
of corporate income in the UK creates distortions over how firms
raise funds (debt or equity finance), over investment decisions,
and over decisions to incorporate. Recent research also shows
a close correlation between corporate taxation, wages and employment
(put slightly differently, much of the incidence of corporate
taxation falls on labour[56]).
An additional behavioural response for internationally mobile
companies is to opt out of a particular tax system altogether.
Where taxes are levied on bases which are particularly responsive
to price changes, the potential impact on behaviour and, therefore,
growth is greater.
Tax levels
Source: KPMG's Corporate
and indirect tax survey 2010
Headline corporate tax rates are an important indicator
of tax competitiveness, though not the only one. The UK's lead
on corporation tax rates has been eroded in recent years, as other
countries have cut their corporation tax rates further and faster.
The UK currently has the 7th lowest rate of corporation tax in
the G20 and the 20th lowest rate in the EU27. In 1997 the UK had
the 10th lowest main rate among the EU27 countries; by this year
it had slipped to 20th.
The introduction of the 50% personal tax rate has
also affected the UK's competitiveness. In particular, combined
with the implications of other tax changes, such as the banking
levy, "one-off" bonus taxes and restriction of pension
tax reliefs, the competitiveness of the UK as a financial centre
has been affected. Research has shown a strong link between tax
rates on high earners, and levels of FDI.[57]
Companies will tend to look at effective tax rates
rather than marginal tax rates in their assessment of whether
to invest and the costs of doing business in a particular tax
jurisdiction. The effective average tax rate (EATR) is the proportionate
difference of the net present value of a profitable investment
project in the absence of tax and the net present value of the
same investment in the presence of tax. Effective rates are a
more accurate reflection of the true burden of corporation tax
on UK business. Our members confirm that this is borne out in
practice. For discretionary "big ticket" investments,
such as installations in the infrastructure or energy sectors,
the combined cash effect of the tax on project profits and the
tax relief on the upfront investment can influence which country
is the most deserving location when there is limited capital available.
According to analysis by the European Commission,
the UK had an (EATR) for corporations of 29.3% in 2007 compared
with an EU27 unweighted average of 22.3%. The UK's effective rate
is somewhat below that in, for example, the US (36.9%), Canada
(36.0%), Germany (35.5%). Countries with lower effective rates
include Ireland (14.4%), Switzerland (18.8%) and Norway (24.5%).[58]
TAX STRUCTURE
The tax system as a whole can also be structured
so as to support economic growth, minimising the distortionary
impact on economic decisions and maximising revenues. The OECD
has done some valuable work in this area, culminating in its recent
report on growth-oriented tax policy reform.[59]
Recurrent taxes on immobile property are consistently
found to have the least distortive effects on long-run GDP per
capita, followed by consumption taxes, other property taxes, environmental
taxes, personal income taxes and corporate taxes. However, the
OECD acknowledges that it is politically difficult for governments
to shift the tax base onto property, which tends to receive tax
breaks.
An alternative is to shift towards consumption taxes
and away from income taxes as has been occurring over the past
few decades since the Meade report. This has happened to some
extent in the UK, following the increase in personal allowances
for basic rate taxpayers and the recent increase in VAT. The recently
published Mirrlees review into the UK tax system looks comprehensively
at the different options for optimal tax structure. Changes in
income taxes will have implications for both the number of working
hours undertaken by those already in work, and the labour market
participation decision. The review notes that, taking into account
the interactions between the benefit and tax system, many of those
with the lowest incomes face the highest marginal tax rates. The
sharp increase in tax rates for mobile higher earners, for example,
is expected to affect the choice of entrepreneurs to locate in
the UK. The OECD finds that a reduction in the top marginal tax
rate is found to raise productivity in industries with potentially
high rates of enterprise creation.
Corporate income taxes are viewed as the most harmful
for growth as they discourage the activities of firms that are
most important for growth, namely productivity and profitability
enhancing investment. The OECD finds that lowering headline corporate
tax rates can lead to particularly large productivity gains in
firms which are dynamic and profitable. However, lowering the
corporate tax rate substantially below the top personal income
tax rate incentivises high-income individuals to shelter their
savings within corporations, ie is counter to the principle of
tax neutrality.
The Mirrlees review looks at the effect of the corporate
tax system and the differential tax treatment of debt and equity
and the effects on investment. Alternatives proposed include cash
flow taxes, the Allowance for Corporate Equity (ACE) and the Comprehensive
Business Income Tax (CBIT). Any of these would result in the equalisation
of the treatment of debt and equity finance (something similar
to ACE was introduced in Belgium in 2008). The first two proposals
essentially extend tax relief to equity-raising, while the third
abolishes tax relief for debt finance. All would be difficult
to implement as the first two would involve narrowing the corporate
tax base, while the last would put the UK out of kilter with international
competitors.
In the latest HMT publication on Corporate Tax Reform,[60]
and in line with our Tax Task Force report recommendations, the
Government has committed to maintaining the position of interest
as a legitimate business expense, and thus tax deductible, given
that this is considered one of the more competitive features of
the UK tax system.
Broad base-low rate
The OECD also looks at base broadening accompanied
by rate lowering as a means of increasing the efficiency of the
tax system.[61]
Benefits of a broad base-low rate combination include:
— Fewer
distortions due to fewer exemptions.
— Higher
tax compliance due to reduction in arbitrage opportunities and
lower rates.
The Mirrlees review notes that the UK corporation
tax rate has fallen from 52% in 1982-83 to 28% in 2009-10 and
is set to fall further to 24% by 2014-15. Despite this, corporate
tax revenues have remained stable at a little over 3.5% of GDP.
This is at least in part because cuts in corporation tax main
rate have been accompanied by reductions in reliefs and allowances
or other extensions to the corporate tax base.
The Office for Tax Simplification (OTS) recently
published a list of UK tax reliefs and exemptions. They will be
making recommendations for action in the 2011 Budget on 23rd
March.
OTHER FEATURES
OF A
GOOD TAX
SYSTEM
This section outlines the characteristics associated
with a "good" tax system. In its 2008 Report on Tax
Reform, the CBI Tax Task Force identified the following key principles
which should underlie tax reform:
— Neutrality
(ie, tax should not distort business decisions).
— Simplicity
and clarity.
— Certainty
and stability.
— Flexibility
in response to changing business practice and competitive pressures.
Tax policy making which takes these into account
can help minimise the burden of tax compliance. However,
some of these will trade off against each other. For example,
a complex tax system would benefit from simplification to help
reduce compliance costs. But, changes in the tax system create
uncertainty and, therefore, impact on the longer term investment
plans of companies.
Neutrality
Tax neutrality essentially means that the tax system
should not distort choices and behaviour, i.e. that taxpayers
in similar situations and carrying out similar transactions should
be subject to similar levels of taxation. So, for example, the
incomes of employees, the self-employed and small companies should
be taxed at the same rate. A non-neutral system creates incentives
to reduce tax payments by changing behaviour—the behavioural
response. This may be either a deliberate policy choice, such
as in the case of taxing polluting industries more heavily, or
incidental to the revenue collection objective. Revenue-reducing
behavioural responses may be countered by the government developing
anti-avoidance legislation, which tends to increase legislative
complexity and compliance costs. It should also be noted that,
in the cross-border context, the Treasury has explicitly abandoned
Capital Export Neutrality, ie trying to exactly equalize the tax
treatment of foreign and domestic investments.
Clarity and Simplicity
Legislative clarity is important as it enables companies
to comply more easily as tax liabilities are easily understood,
and should reduce costly and time-consuming disagreements with
the tax authorities. Tax compliance should not require an excessive
amount of company resource, which would divert energy from more
productive and profitable business activities. Tax complexity
may be a particular issue for SMEs as compliance costs represent
an almost fixed cost and SMEs are also less able to afford to
take the steps to minimise their tax liability. Unfortunately,
there may be a trade-off between clarity and simplicity. To provide
greater clarity on the scope of a tax, for example, legislation
may need to be lengthy, which may be considered to reduce simplicity.
Tax incidence is important when considering ways
in which the tax system can be simplified. For example, both employers
and employees pay national insurance contributions and employees
also pay income tax. But employer contributions affect employer
decisions about pay and employment levels which ultimately are
borne by employees. Tax incidence is particularly important when
considering changes to corporate taxation as taxes are ultimately
paid by individuals, ie employees or customers. In general, corporate
taxes lead to a lower level of investment leading to lower capital
per worker, which lowers wages.
Stability, certainty and predictability
Companies make long term investment decisions over
substantial time periods and need to do so in a tax system which
is stable in order to receive the expected return on investment
(which may then, for example, encourage further investment). Stability
in the tax system gives companies certainty about their ongoing
tax liabilities and when they fall due. However, changes in the
tax system that reduce complexity introduce instability so an
assessment needs to made about the relative importance of these
factors. For example, businesses may have a preference for government
flexibility in tax setting where it is an appropriate response
to tax developments in competitor jurisdictions. The government
can work to minimise the adjustment costs associated with changes
in the tax system. An adequate notice period for tax changes,
the involvement of tax professionals in the design of taxes and
an avoidance of retroactive tax changes (including by grandfathering
provisions) can all help companies adapt. An appropriate balance
obviously needs to be struck between government having flexibility
in policy making and the business need for stability.
Administration and collection
Changes in the way in which taxes are collected can
be every bit as disruptive as changes in the underlying legislation.
As well as bearing the economic burden of some taxes, companies
also act as unpaid collector of many other taxes[62]
for government, and the systems costs and complexity to do so
can be highly material. A change in the interpretation of tax
law by HMRC makes it difficult for businesses to predict the impact
of complying with tax legislation.
The Mirrlees review states that the tax system should
be judged by its impact on the trend rate of economic growth.
An appropriate tax policy, taking into account the issues raised
above, will help support economic growth. Adherence to these tax
principles will give companies the confidence to invest in the
UK, helping boost investment and productivity.
3. To what extent should the tax system be
structured to support other specific policy goals?
To reiterate, we believe that the tax system should
be as non-distortive as possible. And, furthermore, even if a
policy aim is thought to be worth pursuing, the question should
always be asked whether the tax system is the most efficient method
of delivery. The tax system is often a blunt and indirect tool,
and, additionally, using the tax system in this way inevitably
increases complexity. However, taxation is often chosen as the
policy instrument for changing behaviour to deliver a government
policy objective, such as promoting innovation or to support environmental
objectives that the market seems unable to deliver. In such cases,
the importance of the behaviour change for increasing growth or
addressing other policy objectives is believed to outweigh other
principles of tax design.
The haste with which some tax policies with a behavioural
objective are developed, however, may mean that insufficient consideration
is given to the principles of good tax policy. A number of taxes
have been, or are set to be, introduced to counter perceived market
failures in the financial services sector, namely the bonus tax,
50% higher tax rate and bank levy. These have a number of objectives,
including countering excessive risk taking by individuals and
inadequate regulatory structures. The 50% personal tax rate, for
example, was implemented partly with a revenue-raising objective
and partly following the backlash against aspects of the financial
system following the crisis. It was arguably aimed at correcting
a market failure, namely that financial sector pay was inappropriately
structured to encourage excessive risk-taking. But there are,
arguably, much better ways of approaching this issue, and many
of the principles of good tax policy making were set aside in
the announcement of this policy. The way in which the 50% rate
fitted with other policy announcements, such as changes to NICs
and pensions taxation, and the scaling back in the tax free allowances
for particularly high earners, led to substantial distortions
in the tax treatment of earnings above £100k. In particular,
it failed the competitiveness test, making London less attractive
relative to other jurisdictions for mobile high earners.
4. Are there aspects of the current tax system
which are particularly distorting?
From the perspective of a neutral tax system, there
are a number of taxes which are distortionary. Again, the ideal
of a neutral tax system needs to be considered alongside other
government policy objectives which distortionary taxes may be
designed to address. There are some areas of the tax system, for
example, which are distorting but can be justified on other grounds.
— The
tax treatment of foreign earnings.
— Taxation
of financial services.
— Taxation
of innovation.
— Tax
treatment of those with non-domiciliary status.
— Zero
tax relief for a significant part of the cost of investment in
the UK's infrastructure.
There are also, however, a number of areas within
the the business tax system which definitely require changes to
remove distortions. These include:
— Taxable
profit to comprise all business income less all genuine business
expenditure;
— Abolition
of the schedular system;
— Elimination
of tax nothings.
5. How much account should be taken of the
ease and efficiency with which a particular tax can be imposed
and collected?
To be able to levy a tax, the tax authorities need
to be able to identify the base on which the tax is to be levied.
Changes in tax rates often lead to a behavioural response where
the affected individual or firm work out the best way to organise
their activities so as to minimise their tax liability. The government
will then often respond through tightening up anti-avoidance legislation.
This leads to a steady escalation in complexity and compliance
costs.
Those taxes which are easiest and most efficient
to collect are more likely to be supportive of economic growth.
Such taxes would have lower compliance and administrative costs
and be straightforward in their coverage, minimising the uncertainty
which undermines competitiveness. However, this should be considered
alongside other important characteristics for an efficient tax
system.
The current source-based corporate income taxes have
very high administrative and compliance costs, for example, in
the setting of intra-firm transfer prices. The generally favourable
tax treatment of debt encourages multinationals to raise debt
in high-tax jurisdictions to maximise the tax relief. This then
leads to the development of complex anti-avoidance rules, such
as thin capitalisation which seek to limit the tax deductibility
of interest. The worldwide debt cap also seeks to limit the amount
of debt that multinationals can set against tax in the UK. The
tax treatment of interest is a particularly good example of excessively
complex and largely unworkable legislation aiming to set limits
on reliefs.
Another example is the CFC regime, where the current
rules make it difficult for UK headquartered multinationals to
finance their non-UK operations in the most efficient way, for
example using surplus cash from one foreign subsidiary to fund
another foreign operation. The UK has become perceived as particularly
aggressive both in terms of the rules themselves and the way that
they are interpreted. Any move into a low tax jurisdiction is
likely to be treated as tax avoidance regardless of the existence
of commercial motives, and the available exemptions are both restrictive
and administratively burdensome.
CFC reform has been needed for many years, and the
complexity of the rules and uncertainty over reform has contributed
to decisions of a number of high profile UK listed companies (eg
Wolseley, WPP, Shire) moving their tax base offshore/inverting.
While tax rate competition is an obvious factor, many of these
companies have cited the prolonged uncertainty over CFC reform
as the main reason.
The CBI has, therefore, welcomed publication of the
Government's Roadmap for Corporate Tax reform, which includes
major reform of the CFC rules. Complexity and uncertainty in the
tax system has a major impact on the competitiveness of the UK
as a place to do business, and it is essential that tax policy
takes this into account.
January 2011
56 Arulampalam, W et al, "The
direct incidence of corporate income tax on wages", May
2008 Back
57
Buettner, T and Wamser, G, "The impact of non-profit taxes
on foreign direct investment: evidence from German multinationals",
June 2006 Back
58
Elschner, C and Vanborren, W, "Corporate effective tax
rates in an enlarged European Union", Taxation Papers,
European Commission, 2009 Back
59
OECD Tax Policy Studies, "Tax Policy Reform and Economic
Growth", Tax Policy Study No. 20, 3 November 2010 Back
60
HM Treasury, HMRC, "Corporate Tax Reform: delivering a
more competitive system", November 2010 Back
61
OECD Tax Policy Studies, "Choosing a Broad Base-Low Rate
Approach to Taxation", Tax Policy Study No. 19, 28 October
2010 Back
62
Eg PAYE, employee NIC, VAT, CCL Back
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