The first of Prime Minister David Cameron’s business-friendly initiatives rolled out in early July, and the changes are receiving mostly warm welcomes from UK business leaders. The measures gradually reduce corporate taxes, from the current 20% to 18% by 2020, as well as lower tax rates on banks.
Aimed at boosting growth and employment, the planned cuts in the UK corporate tax rate will position the country as having the lowest tax rate of any country in the Group of 20, an international forum of 20 major countries. UK Finance Minister George Osborne estimates the tax changes will benefit more than 1 million businesses.
Despite applause from most business leaders, the government strategy of cutting corporate taxes to foster growth and attract foreign businesses also is receiving some criticism. Some small companies claim that although the main tax rate has fallen from 28% in 2010 to 20% this year, lower corporate taxation has not yet translated into higher profitability.
According to Helen Dickinson, director general of British Retail Consortium, the interest rates banks charge on loans to small businesses (despite record-low interest rates) are weighing on small businesses’ balance sheets more than corporate taxation. For every £1 retailers pay in corporate tax, they pay £2.30 in interest on loans. Second, as Richard Murphy of Tax Research UK observed, the benefits of a strategy that attracts financial relocations from abroad to the UK but doesn’t generate much underlying investment or create employment are questionable overall.
In addition, the business groups’ enthusiasm has been partly curbed by a corresponding government-mandated increase in the so-called “national living” wage (from current £6.50 an hour to £9 an hour by 2020). The Center-Right Conservative Party, which retained power in last May’s election on Cameron’s pro-business agenda, also added a new apprenticeship levy on large corporations and cut tax breaks for investment.
Furthermore, research by the Institute for Fiscal Studies reveals that tax receipts fell from £46.3 billion in 2007-08 to £39.3 billion in 2013-14 and are forecast to remain below the precrisis peak until the end of their five-year forecast horizon, reaching £42.0 billion in 2019-20.
Detractors of Osborne’s “Emergency Budget” have argued that the government might eventually be forced to cut welfare further to make up for lower corporate tax revenues at a time when painful spending cuts are already being inflicted on Britain’s public sector.
On the banking side, the government’s actions send a mixed message. On the one hand, the government aims to increase the UK’s reputation as a good place for banking by phasing out a levy on domestic banks. Indeed, analysts believe the plan should eventually lead to lower bills for banks like HSBC and Standard Chartered, and could encourage financial institutions not to relocate their headquarters outside the UK.
On the other hand, a new 8% surcharge on banks’ profits will be assessed beginning in 2016. According to government’s estimates, the surcharge should raise more money from financial firms in the next five years than the levy would have raised. Together the changes will result in an additional £1.7 billion from banks over the next five years, according to Treasury figures.
Uncertainty stemming from the medium-term possibility that the UK could leave the EU is clouding the financial sector’s outlook in the quarters ahead. Indeed, research from Open Europe suggests that financial services are most exposed to a Brexit (as a possible British exit from the eurozone is known) and would lose their single-market “passport.”
Banks might have to establish subsidiaries to maintain access to the single market. Some banks are already starting to move their European bases to Dublin. US bank Citigroup is relocating its European retail banking headquarters to Dublin to bring down its cost base. HSBC is also mulling over whether to keep its global headquarters in the UK and has issued dire warnings about the consequences of the UK leaving the EU.
Daniele Fraietta has been a D&B economist for more than two years. He currently covers some Western European countries, notably Italy, Greece, Spain, and Ireland. For D&B, Daniele has also developed the new econometric framework for commodity prices and exchange rates forecasting. He has an MSc in Economics from the University of Rome Tor Vergata, a Master in Business Administration from The Polytechnic University of Milan, and a Master in International Business from the Chapman College of Business.
Photo courtesy HM Treasury.