This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government
Speech by the Exchequer Secretary to the Treasury.
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It is a great pleasure to be here today and I am delighted to have this opportunity to share with you the principles behind some of the measures in last week’s Budget and to set out my vision for reforming the tax system in the years ahead.
In recent months, the British economy has come out of the worst recession since the 1930s and we are now faced with the questions of how to deal with our debts and ensure a strong enterprise-led recovery.
That was the objective of George Osborne’s Budget last week and the overriding reaction, certainly from the business and economic analysis, is that his plans successfully set us on the right path.
When faced with such an enormous challenge as restoring Britain’s worst public finances in peacetime history and when faced with painful choices whichever way you look to solve the crisis, it may seem to some that the easy way out would be to rely heavily on taxes, and an easy target for tax rises might be business.
But a thriving private sector must be at the heart of our plan for growth, because as we reduce spending - as we must if Britain is to live within her means - only the private sector can spearhead the recovery.
Of course there are always sceptics and indeed in the last week some people have raised their doubts as to whether the private sector will be able to mobilise quickly enough to provide the growth and the jobs needed. The question of where exactly the growth or the jobs will come from has been on the lips of many a media pundit in recent days.
As the Chancellor has said, there is no lever we can pull to answer that question in Government. I cannot specify the exact shape of the economy in five years, accurately predicting every area of growth in the private sector.
Instead we need to ask ourselves what Government can do to provide the right environment for the economy to flourish once again. What will it take for business to plan and invest with confidence?
My subject today is one of the foundations - a reformed tax system. In particular it is the twin aspects of the competitiveness and stability of the tax system that I want to address today.
Opening Britain for Business
Turning first to competitiveness.
In Britain, business has always been at its best as a global player, playing to our strengths and following our instincts as a free-trading outward looking economy.
Given our history and culture, we should be well placed to benefit from globalisation. But to do so means attracting business from abroad and making Britain a place where people choose to do business and choose to locate.
We need to demonstrate that business from all around the world is welcome in Britain.
But the competitiveness of our tax system in this respect has taken a dive over the last decade. For example, in 1997 the UK had the tenth lowest main rate of corporation tax among the current EU27 countries. But other countries have cut their corporation tax rates further and faster than we have. We have now slipped to twentieth.
Compared to Germany, our rate was nearly 24 percentage points lower in 1997, but is now less than two percentage points lower.
We need to show that Britain has an attractive tax system and is open for business.
It is only by being competitive and attracting investment that we can secure economic growth, rises in living standards and the funding of public services for the long term.
Making our tax system more competitive in a broader sense, means also reducing the harmful effects that taxes can have. Where we can - where it is consistent with fairness and our other policy objectives - we must reduce the taxes that distort economic choices.
Taxes raise vital revenue, and can address market failures. But they can change the prices of goods and services in undesirable ways. They can distort the choices of individuals and firms that are particularly important for GDP growth like investment, education and labour supply.
The evidence shows that different types of tax vary in the degree to which they distort choices and therefore the impact that they have on growth.
The OECD’s estimates suggest that corporation tax, for example, is the most growth impeding tax, followed by personal income tax and then consumption tax. So the economics would suggest that if you do need to raise £12 billion, VAT is the least bad tax to raise.
The case for reform is urgent. Richard Lambert, Chief Executive of the CBI has described our tax system as a “ball and chain round the ankle of the UK economy”.
What is disappointing about this was that just a few years ago our tax system was seen as an asset. And it needs to be an asset again.
To get there we need radical reform. Last week, while our focus was tough but fair action on the deficit, we also took some significant first steps to address this and we intend to make further strides over the Parliament.
Lessons from history
As we set about our task to reform the tax system, especially business tax, I’ve found myself reflecting on the words of a great tax reformer of the past, Nigel Lawson.
In his 1988 Budget statement, Lawson set out his four principles for tax reform, principles which remain pertinent today:
- “first, the need to reduce tax rates where they are clearly too high;
- second, the need to reduce or abolish unwarranted tax breaks;
- third, the need to make life a little simpler for the taxpayer;
- and, fourth, the need to remove some manifest injustices from the system.”
Of course, there are some distinctions we can make with the approach of the 1980s. On personal taxation, for example, the Coalition Government places greater emphasis on ensuring that changes are progressive. But as a blueprint for business tax reform there is much to build upon from this approach.
I see two lessons to learn:
First, having the courage to put economics ahead of politics. It’s often politically tempting to raise taxes on business, but in the long run good economics is good politics, as we reap the fruits of reform in the years that follow it.
This informs our approach in the Budget and particularly our approach to reforming business taxes. It might be the easier in the short term political choice to put up taxes on business rather than those that seem to hit closer to home, but we need to take decisions from which we see the rewards when we look back in 5 or 10 years time.
The second key lesson to learn from Lawson is to be careful with proposals that would deliberately use the tax system to distort choices and thereby effectively micromanage people’s spending and investment decisions.
As a general rule, it is preferable to have fewer breaks but lower rates.
We should avoid tax policy becoming a bidding war as various sectors seek preferential treatment at the expense of wider business interests. In that context, we did not think it was justifiable to introduce a poorly targeted tax break for the video games industry.
The desire to avoid using the tax system to micro-manage investment decisions was also a factor in our decision not to reintroduce taper relief for CGT. Taper relief imposes economic distortions in that it exacerbates the incentives for individuals to hold assets for longer than they would in the absence of CGT.
As we reduce tax breaks, we reduce the opportunity for tax avoidance- an issue which we as a Government take very seriously.
By complicating the tax system, reliefs and exemptions open the door to avoidance. Lawson makes an observation about this too when he says:
Tax breaks are inevitably used as methods of tax avoidance, which means that the general level of taxation has to be still higher to bring in the required revenue.
And, of course, many of the responses to tax avoidance put forward then in turn further increase complexity. Over the long term we need to simplify the tax system to reduce avoidance opportunities - and we need to watch the flow of tax measures carefully.
We are also discussing a general anti-avoidance rule and we are encouraging HMRC to take every possible step to clamp down on avoidance activity.
So it is with these principles of economics ahead of politics and seeking simplification in mind that we have set about reforming corporation tax with the aim of greater international competitiveness as well as greater economic efficiency.
Corporation Tax Reform
Last week the Chancellor announced that we will cut corporation tax by one per cent to 27 pence in the pound in the next year and that we will cut it again by one per cent in each of the following three years. Four annual reductions in the rate of corporation tax that will take it down to just 24 pence.
This will give us the lowest rate of any major Western economy, one of the most competitive rates in the G20, and the lowest rate this country has ever known.
I make four arguments for prioritising this move:
First corporation tax rates are important in themselves in selling the UK. They are an advert for an economy as a good place to do business.
Second, it is a necessary step to help rebalance the economy. As we take tough measures to scale back the public sector, we must provide the necessary boost to the private sector.
Third, as I mentioned in my introduction, corporation tax is an inefficient and growth damaging tax. Lower corporation tax rates encourage investment - and it is investment we need to support the recovery.
Fourth, far from merely being a tax cut for profitable companies, this is a tax cut which will support jobs in the private sector.
As the Business Secretary Vince Cable has said:
Companies are, of course, not individuals but legal entities. Any corporate tax is ultimately passed on somewhere else - in reduced dividends or wages or in higher prices.
This is absolutely right and the evidence points to the tax incidence falling in part on labour. So this is a tax cut that, like our policy on employers’ National Insurance Contributions, will help preserve and create jobs.
Alongside a cut in the main rate, the Budget also announced that we will cut the small profits rate, reversing the previous government’s plan to increase the rate next year to 22 pence and instead cutting it to 20 pence, reducing the tax rate on some 850,000 companies.
As we lower rates, we will reduce capital allowances, so that they are broadly in line with economic depreciation across the economy. This Budget announced a reduction in the capital allowances main rate from 20 per cent to 18 per cent, and the special rate from 10 per cent to 8 per cent from April 2012.
And we announced a reduction in the Annual Investment Allowance from £100,000 to £25,000 from April 2012.
The reductions in allowances will take place from April 2012 to give companies the early advantage of the reduction in headline rates and notice of the changes. From April 2012, capital allowances will remain broadly in line with economic depreciation across the economy, and more than 95% of businesses will still have all of their qualifying plant and machinery expenditure fully covered by the annual investment allowance.
We are also taking forward a programme of reforms to the rules for taxation of foreign profits to deliver a more territorial tax system - including the Controlled Foreign Company rules and the taxation of foreign branches - to help enhance the UK’s competitiveness, while still providing adequate protection of the UK tax base.
The Budget announcements on corporation tax were principally about reducing rates. But we also want to take a little more time before publishing further plans on the long-term future of CT.
For example, in the context of a globalised economy with highly mobile flows of labour and capital, while we do need a tax system that doesn’t pick winners, there are some cases, such as intellectual property, where the mobility of activities and the spillover and public benefits they can bring make the case for intervention through the tax system.
We have decided to take the opportunity to look at this in the round. We will consult with business to review the taxation of intellectual property, the support R&D tax credits provide for innovation, and the proposals of the review by James Dyson on making the UK the leading high-tech exporter in Europe.
In summary, we are taking serious action to improve the competitiveness of the UK tax system in a way that is consistent with cutting the deficit. This will help to rebalance our economy and put Britain back on the map as an attractive place to do business.
In delivering these changes we must listen carefully to businesses, and to what they tell us will really encourage them to invest further in the UK. I can therefore announce today that I will be chairing a forum for multinational business leaders to discuss ways in which we can improve the competitiveness of the UK’s tax system, including the long-term aims of the corporate tax system.
Members will be drawn from across industry - manufacturing, pharma, oil and extraction, financial services - to ensure that we listen to a variety of viewpoints on the reforms. Details of full membership will be published shortly and the aim is to hold the first meeting in July.
To ensure that this group has access to the highest quality economic advice, I am also pleased to announce that I have invited our host today, Mike Devereux, to join the forum.
Approach to Tax Making Policy
I have drawn a lot so far on Nigel Lawson’s tax reforms, but he’s not the only former Chancellor with a strong influence on our approach. Because alongside competitiveness, the second aim of our tax reform strategy is to create greater stability in the system. And it is to the deliberative tax making approach championed by Geoffrey Howe that we have turned for inspiration.
In the 2008 report of Lord Howe’s working party on tax simplification he states that:
Over the [the past decade] the capacity of Parliament to scrutinise tax legislation has been overwhelmed” and that “Pre-legislative consultation is still too often regarded by Governments as a luxury.
Lord Howe’s report recommends a series of measures to develop a much more rigorous and accountable tax law making process.
Making the right decisions on tax policy is critical. But a competitive tax system is not only about the level of taxation and the policy choices that determine its incidence, it is also about the quality of tax law and the way we make tax policy.
The very process of making tax law is a difficult one. Business and tax professionals (indeed many of you here today) have consistently pointed to the way in which tax policy is made as a contributing factor to overall complexity and uncertainty.
So, as a Government, we want to reform the framework for developing tax policy and making tax law. A framework that puts predictability and stability first and prevents the culture of tax policy by press release that has been all too prevalent in recent years.
We set out this approach in a discussion document published alongside the Budget last week. The warm welcome it has received reinforces my strong belief that getting this right really matters. And we really do want to get it right. We want to talk to all interested parties about how best to build a framework for making tax law that is:
- Not haphazard but predictable - based on a clear strategy which produces greater certainty about the future
- Not disorderly but stable - focusing on fewer, better developed proposals; getting legislation right first time through proper consultation and allowing time for better scrutiny
- Not opaque but transparent - explaining our rationale, sharing our analysis and assumptions.
Building the framework and changing the way that tax law is made in the UK may take some time and it will be challenging.
As William Gladstone noted when he was Chancellor of the Exchequer in the 1850s:
To bring the construction of tax laws within the reach of persons who have not received a legal education is no doubt desirable, but very far from being easy.
That is no exaggeration - but we believe that it is possible to develop a new approach. Even in this Emergency Budget, with all the tough choices that were necessary, we were able to provide certainty by setting out a roadmap for reducing corporate tax rates.
Departing from the past, our Budget was also more transparent, for example we published for the first time a distributional analysis of the measures we have taken, as well as the detail behind the costing of our tax and welfare decisions.
There also is significant work to be done to correct the mistakes of the past by reducing existing complexity in the British tax system. We will therefore be establishing an independent Office of Tax Simplification to help us do just that. We will announce further details on this shortly.
In summary, our approach to tax reform will very much be one of fewer surprises. I should admit there were a few surprises for the business community last week - but I hope at least that we surprised on the upside.
Tax Professionals Forum
To help us develop this approach, I can announce that I will also be chairing a new forum for tax professionals to oversee this new approach and challenge us on whether it is having an effect on the stability of tax policy and the quality of our tax law.
I am delighted that we have brought together a strong group of tax professionals, business leaders and academics. The full list of members will be published on our website.
By way of conclusion I would say that the British tax system is an asset to our economy, just like our language and our legal system.
As a Minister I want to make the case to the international business community that the UK is the right place to do business and that our tax system is one reason why.
Like all assets, we need to maintain the tax system carefully - and ensure, it does not fall into disrepair - in order to get the most out of it. Faced with the tax system we have inherited, we will introduce reforms that promote greater competitiveness and greater stability now and over the Parliament.
We will avoid knee-jerk, populist measures and taking the long view, making policy choices that are shown to be right 5 or 10 years down the line.
If we get these reforms right, they will help pave the way to bringing more international business to the UK, which will give our economy the boost it so urgently needs now and in the years ahead.
This is a huge challenge and it is a challenge that we won’t succeed in without the help of tax professionals and business people of the kind that are here today.
I think we have made a great deal of progress in our first eight weeks in government but I look forward to working with many of you in the months and years ahead, so that together we can turn this vision into a reality.