David Gauke – 2010 Speech on Taxation and Growth

Below is the text of the speech made by David Gauke at the Policy Exchange on 22nd March 2010.

It is a great pleasure to speak at today’s event and can I thank Policy Exchange for producing this thought-provoking report.

I want to address most of my remarks to the issue of corporation tax reform and the issues related to that set out in this report.

But before doing so, I would like to say a few words about what is clearly the most eye-catching aspect of this report, the analysis of the impact on jobs and growth of changes in Employers’ National Insurance Contributions.

The report argues that raising this tax appears to be one of the most damaging ways of raising revenue.  The most striking statistic is that the Oxford Economics model predicts that a 2p rise in employers’ National Insurance Contribution means that GDP will, in three years’ time, be 2% lower than it would otherwise be.  And, extraordinarily, that unemployment would be higher by 1m.  The consequence is that, uniquely amongst the tax rises considered, it has a negative impact on the government balance.

These are such striking numbers that the authors of this report urge caution in accepting them.  But what is very striking is that the Treasury model would, apparently, show the same effect.

And this begs the question, what was the advice that the Treasury provided to Ministers in the run up to the announcement in December 2009 that NICs would be increased?

We know that the Treasury was briefing that it was unhappy about the policy and prevailed upon by the Prime Minister.

But did Ministers receive advice that an increase in employers’ NICs would have a significant impact on jobs and growth?

Given what the Treasury model appears to tell us, we can only assume that they did.  And if so, why did the Government proceed with this policy?

This report throws down a significant challenge to the Government.

What is its assessment of the consequences for jobs and growth of raising Employers’ National Insurance Contributions?

Does the Treasury model point to a substantially different impact than is claimed in this report?

Unless the Government comes clean on this issue, there is a strong suspicion that the Government is deliberately pursuing a tax rise which will increase unemployment, slow growth and do nothing to reduce the deficit.  If these numbers are right – and it remains a question – it appears that the Government has once again put politics before economics in a way that is quite scandalous.

Let me turn to the issue of corporation tax.

We have long argued that we should look to broaden the base and lower the rates in the context of corporation tax.

In 1997, our corporation tax rate was lower than the OECD average.  Now it is higher.  In 1997, our corporation tax rate was the 11th lowest, now it is 23rd. We used to have the 3rd lowest in the EU15, now it is the 6th highest.  While the rest of the world has been cutting their corporation tax rates substantially, the UK has been caught up and, in many cases, overtaken.

Although this view is not universally held, we share the view of many commentators and business groups that the corporation tax rate is one of the key measurements in assessing the attractiveness a place to do business.  It is not the only consideration, but if we are to send out a message that the UK is an attractive place to do business and locate profits, a lower corporation tax rate is an important attribute.

And a lower corporation tax rate allows moves towards further simplification.  Rate differentials drive tax avoidance behaviour and this, in turn, drives further tax complexity as the Treasury and HMRC try to prevent this happening.

We are committed reducing the headline rate from 28% to 25% or lower by reducing capital allowances and believe that the UK economy will benefit as a whole from this.  By moving towards a system whereby capital allowances more closely reflect the level of accounting depreciation, we can reduce complexity.  And, given our belief that manufacturing has an important role in future economic growth, we have been engaging constructively with the Engineering Employers Federation and we are keen to consult further on their ideas for a short life asset regime which better reflects the reality of the depreciation rate for certain assets

I have mentioned capital allowances but there are further measures that we can take that would enable us to further lower the corporation tax rate in a broadly fiscally neutral manner.

This brings me to the subject of interest deductibility on borrowings.

For some time, we have argued that there is a need to rebalance our tax system by reducing tax breaks for debt.

First, it will enable us to lower the corporation tax rate which we believe is important in itself.

Second, we believe that our tax system currently favours debt over equity.  As the Policy Exchange paper sets out, the current distortion in favour of debt makes businesses more volatile – prone to exuberant growth in the good times but vulnerable in the bad times.

We do, of course, acknowledge that tax is not the only reason why businesses choose to finance themselves with debt.  Debt can provide a degree of flexibility in financing businesses that equity cannot match and can be cheaper than equity.  For many businesses, the responsible use of debt is clearly a key element in financing.  Our focus is the desire to temper exuberance in leverage whilst not discouraging inward investors in trading businesses that generate employment in the UK.

Nonetheless, we believe that the balance of treatment within the tax system is not right and this can lead to distortions.

To take an extreme and topical case, the current structure of our tax system appears to encourage the situation whereby a successful and profitable business, like Manchester United, becomes loaded down with debt as a consequence of a leveraged buy-out.  Profits and corporation tax payments are reduced as interest payments are increased and the business could find itself in a precarious situation if its success is not continued.

This may be a tax efficient structure but it is difficult to see how this is good for the long term interests of the club, good for football or good for the country.

The Policy Exchange paper highlights the fact that if interest deductibility were to be abolished outright, the corporation tax rate could be reduced to 17%.

Rightly, the paper points out that this would constitute a very major change in the structure of our taxation system and that any such a move would need to be done with great care.  Regard should also be had to pre-existing arrangements and the critical need to avoid deterring vitally needed investment.  We have frequently stated our belief that tax reforms need to be more deliberative and consultative with better pre-legislative scrutiny – as advocated in Lord Howe’s report in 2008 – and this area is no exception.

Of course, it is very easy for this debate to be polarised into either maintaining the status quo in respect of interest deductibility or its complete abolition.

In reality, there are a number of ways in which interest deductibility could be restricted without pursuing a policy complete abolition.  We want to explore these options.  For example, we are looking at the implications of moving to a more territorial system of taxation.  We do not believe, however, that complete abolition of interest deductibility is practical.

Nobody pretends that these matters are simple and we very much welcome a wide, informed public debate about the issues.  It is important that there is proper consultation and that changes are made in a careful and measured way.  Within these constraints, it is vital that we have in the UK a sense of direction for our corporate tax system.

George Osborne has set out our ambition to have the most competitive corporate tax environment in the G20.  He has also said that we will set out our roadmap for the direction of corporate taxation in our first Budget.  This will set out a sense of direction for the next five years.  It will be a coherent strategy for where we want our corporate tax system to be in 2015 and how we will get there.  Having set out the long term changes that our corporate tax system needs, the UK can then look forward to a period of stability in this area.

This is, of course, an ambitious timetable.  However, we have already put in some serious work on this matter.

In the last few months, we have put together a panel of some of the countries’ leading tax experts to help develop options for reforming corporation taxes.  Their role is to set out some options for reform and the consequences of any approach; options which would be for the benefit of the UK as a whole.

The group includes John Whiting, tax policy director of the Chartered Institute of Taxation, Chris Sanger, head of global tax policy at Ernst & Young, tax policy adviser to Labour in opposition in advance of the 1997 General Election, Head of Business Tax Policy for HM Treasury from 1998 to 2001 and chairman of the tax faculty at the Institute of Chartered Accountants of England & Wales, Stephen Machin, special adviser at KPMG and former member of the Tax Reform Commission, Bernard Glass, former tax partner at PricewaterhouseCoopers, and Trevor Evans, former director of business tax at HMRC as well as other senior members of the tax professions.

Many of these people have been putting forward ideas for reforming our corporate tax system for some time.  We have effectively challenged them   to develop some of their thinking for the benefit of us all. This involves issues such as interest deductibility and territoriality, discussed earlier.  It has also been addressing how we can simplify the controlled foreign companies’ regime which we know can be a major disincentive to investment in the UK, and the corporate tax regime more generally, building on the work that has already gone into the discussions with the Treasury and HMRC over CFC reform.

Our objective is to create a tax environment that is good for business.  Good for those businesses already operating in the UK and those who wish to locate their headquarters in the UK.  But also good for those international businesses which want to invest in the UK.

We recognise that the interests of different types of business will not always be identical.  But within the framework of a broader base and lower rates, our objective is to develop a tax system that will be attractive to both outbounds and inbounds.  In short, we want our tax system to be an asset in presenting the UK as a good place in which to do business.

It is evidence of our seriousness in addressing these matters that we have engaged in this process, and are working with such high calibre people, in developing plans in this area.  We hope that this process will mean that, if elected in May, we are in position to move quickly in setting out our thinking in our first Budget.  But I want to stress that we are keen to engage with the wider business community to ensure that we get this right.

There may, unfortunately, be little imminent prospect for reducing the tax burden but there is a prospect of reforming our corporate tax system for the benefit of the UK.

We want to replace complexity and instability with simplicity and certainty.

We want businesses to be able to invest in the UK with the confidence that the UK has an increasingly competitive tax system.

And we want our tax reforms to show that the UK should be the location of choice for business.