Brexit has intensified the macroeconomic risks facing the economy. The top earners, on whose taxes the Treasury relies, will see lower wage growth; other taxpayers will have to pay more. The government won’t be able to rely on borrowing. Uncertainty about the terms and timing of Britain’s exit from the EU is crippling domestic and foreign direct investment. It will also lead to a loss of City business and staff. This will hurt economic growth. The government’s tax policy priorities include increased taxation, the replacement of the EU VAT and customs regimes, and hopefully greater support for R&D, patent box and innovation.
Sam Mitha CBE believes that the government will have to use tax policy to safeguard the economy and jobs.
UK macroeconomic policy was likely to be dominated by political and economic uncertainty, rising inflation, falling investment, ballooning debt and the spectre of higher taxation, even before Britain voted to leave the European Union. The fiscal outlook isn’t promising, whether Britain makes a graceful exit with a smooth transition (‘implementation phase’) or crashes out of Europe. Brexit will have a profound and continuing effect on the British economy, and on tax policy. If Brexit leads to a sharp contraction in the British economy, the government will have to use tax policy to safeguard the economy and jobs.
The inconclusive result of the recent general election has added to the uncertainty surrounding the outcome of the negotiation process. The economic austerity that began in 2010 under the Coalition government has come to an end. Despite allegedly swingeing cuts to government spending and welfare, the Office for Budget Responsibility (OBR) recently reported: ‘The budget is still in deficit by 2% to 3% of GDP – as it was on the eve of the crisis – and net debt is more than double its pre-crisis share of GDP and not yet falling.’ The Institute for Fiscal Studies has suggested that the UK’s tax burden is set to rise to its highest level for decades because the top 10% of earners, upon whose taxes the Treasury relies, will see lower wage growth following Brexit.
The chancellor has announced a more relaxed approach to eliminating the deficit. The government is now facing demands for increased public spending and the removal of the 1% cap on public sector wage increases. It will have to pay attention because the clamour is coming from its own backbenchers, not just the Opposition or the unions. It will be unable to resist the pressure to loosen its purse strings, because it is vulnerable to even relatively small rebellions from its own MPs. This will result in increased government borrowing and higher taxation. Relying solely on higher borrowing to fund current expenditure is a risky option. It would shift the bill to our children at a time when the Brexit vote, diminishing pension expectations and the difficulties the young face in getting on the property ladder are stoking intergenerational tension.
There is limited scope for further spending cuts, particularly on welfare spending. (The government may find chickens coming home to roost on its earlier cuts in this area.) The government has also ringfenced vast swathes of public expenditure, notably the NHS, defence and foreign aid. The Tory party’s manifesto for the 2017 general election omitted its former pledge not to increase income tax, NICs or VAT (the so-called ‘tax triple-lock’). It promised instead to stick to its plans for corporation tax, keep VAT at the same rate, and simplify the system. The government would have the flexibility to increase income tax and NICs. Whether it chooses to do so is another matter, given that it is in thrall to its own backbenchers and the Democratic Unionist Party (DUP). Most government revenue comes from income tax, NICs, VAT and corporation tax. It could either increase the rates of income tax or NICs or widen the basis on which they are charged, e.g. by taxing all forms of work in the same way. Alternatively, it could raise more money through VAT by exempting fewer items, while keeping the rates unchanged. Any such changes would have political consequences because they would create losers.
Britain’s future economic growth has been adversely affected by the uncertainty about the outcome of the Brexit negotiations. Businesses fear that it would be ‘catastrophic’ for the UK to leave the EU without a deal or if there is a Brexit ‘cliff edge’. The gnawing uncertainty gripping businesses is frightening the ‘animal spirits’ of confidence that motivate investment. Investment is essential for sustaining economic growth. The government’s rhetoric about ‘no deal being preferable to a bad deal’ has led to fears that a breakdown in the negotiations could result in the EU treating the UK as a so-called ‘third country’. This could, for example, lead to the grounding of UK air traffic if it ceased to be covered by the European Open Skies and safety agreements.
Government ministers frequently cite strong jobs growth in the UK as a sign of the strength of the economy. We don’t often hear them talk about productivity, for good reason. Productivity growth slowed in most high income countries following the financial crisis in 2007. But the UK’s slowdown was more severe than elsewhere, and it hasn’t recovered. Since its strong jobs growth comes at a time when economic growth is slowing, it implies that its productivity is worsening. According to the Office for National Statistics, productivity fell below its level of 2007 in the first quarter of 2017. The Nobel laureate Paul Krugman reminded us that while productivity is not everything, in the long run it is almost everything.
The UK has a high employment, low productivity economy because it has a very low level of physical investment (including R&D spending), and a large part of its labour force lacks skills. Higher investment would require a longer term focus on the part of the City, lower personal consumption (i.e. higher savings), and continued openness to the talent from abroad. It remains to be seen whether the introduction of the apprenticeship levy will increase the domestic supply of skilled workers. It wouldn’t be advisable to hold one’s breath. According to the CIPD, the UK already spends more money than most large economies on education, but still lags well behind on literacy, numeracy, digital skills and workplace training. Foreign direct investment has boosted productivity in the UK by importing capital, new technology, modern work practices and skilled managers; foreign-owned firms tend to be more productive than domestic companies. But foreign direct investment into the UK has begun to decline, because investors are concerned about Britain’s loss of access to the single market after Brexit.
Businesses have warned the government about the threat to economic growth resulting from the incipient reduction in the flow of highly skilled inward migration from the EU. Many such workers already here are leaving (or planning to do so) because of the uncertainty about their future rights. Access to the EU workforce has provided the British businesses with a safety valve to mitigate the shortage of skilled workers that has previously constrained British economic growth. Survey evidence suggests that the net inflow of skilled workers has slowed. There has been a less marked decline in the inflow of unskilled EU workers attracted by the national minimum wage and the availability of tax credits. The new French government has begun offering inducements to its 270,000 nationals in the UK to return. Many of them run their own business, or hold well-paid roles. If they leave, the government will lose the tax they directly or indirectly contribute to the exchequer.
The Treasury will come under pressure to use its imminent freedom from the EU’s state aid rules to subsidise British industry. The profitability of UK firms that operate EU-integrated business models will be threatened when Britain leaves the single market and the customs union. Foreign-owned businesses are likely to demand assurances of financial support, similar to those that the government provided to the Japanese automobile manufacturer Nissan last autumn. A better use of its post-Brexit flexibility would be to enhance the relief that the government currently provides for R&D expenditure, patent box and through the business department to innovation centres.
The government has already announced its intention to make administrative changes to R&D tax credits. It could go further, substantially increasing the rate at which relief is currently provided for R&D spending, relaxing the rules on qualifying expenditure, or both. Brexit will also give the Treasury the ability to restore the changes it made to the patent box rules under pressure from the EU. Government support for R&D and innovation delivers a very big bang for its buck. For example, the High Value Manufacturing Catapult, which aims to bridge the ‘valley of death’ between technology ideas and preparing products for the market (‘commercialisation’) delivers £15 for every £1 of government investment. Changes to the R&D and patent box rules would help redress the shortfall between UK investment in R&D (1.7% of gross domestic product) and the OECD average (which is 40% higher). The government should match the kind of support that firms on the continent receive or are likely to receive in the future. For example, Angela Merkel’s party has pledged to raise Germany’s R&D spending as a share of GDP from 3% to 3.5% in 2025 by providing £2bn in tax relief.
The UK is a member of the EU Customs Union. Member states trade freely with each other, but are obliged to charge the same tariff on imports from outside the EU. Customs duties are collected on behalf of the European Commission, and not retained by member states for their own use. Since the UK is intending to negotiate its own trade deals with other countries, it will have to quit the Customs Union. There has been extensive coverage of the difficulties this will create for the ‘soft border’ between Northern Ireland and the Republic of Ireland, and the peace process. There has been less coverage of the impact of the UK failing to reach agreement with the EU to facilitate trade. It would result in existing ports having insufficient facilities and staff to cope with the imposition of new customs inspections, duties, VAT collection, and conformity of goods with EU regulations. It will also result in a fivefold increase in the annual declarations that have to be processed by HMRC’s customs declaration service computer system.
HMRC is undertaking a major upgrade of the system, alongside planning new systems for VAT, alcohol and tobacco warehousing, and databases on trader registers. Its new Customs Declaration Services (CDS) project was commenced before Britain voted to leave the EU. The NAO recently reported that no changes have been made to the CDS programme since then, because of the uncertainty surrounding the outcome of the EU/UK negotiations. It noted that HMRC is actively managing the risks and developing contingency plans. And it has called for the government to do more to help HMRC to mitigate the risk of the system being needed, but not ready in time. The media reports of the NAO’s views paid little regard to HMRC’s track record of delivering major IT projects on time. The recent announcement by ministers that Making Tax Digital will be delayed to 2020 at the earliest for taxes other than VAT will free up capacity within HMRC to deliver CDS. But its ability to do so in time is contingent on the timing and terms of any trade deal with the EU.
Leaving the EU would give the UK the opportunity to retain the current structure of the tax, to change it, or to replace it altogether, e.g. with a consumption or sales tax. It is highly unlikely that the government will make any significant change to the existing structure and rates of VAT. The government will want to safeguard the revenues it receives from the tax, some £115bn in 2015/16. This is second only to what it derives from income tax and NICs.
The Scottish government will take a keen interest in any proposed changes to the VAT regime. It has been entitled to half of the VAT receipts collected in Scotland since April 2017. Leaving the structure of VAT as it is would help to facilitate trade with EU members, and avoid imposing additional burdens on business. The jurisdiction of the Court of Justice of the European Union will end after Brexit, but the UK courts will probably be told to heed the CJEU’s rulings on VAT to maintain legal continuity.
In his spring Budget, the chancellor reiterated the government’s intention to reduce the rate of corporation tax to 17% by 2020, the lowest in the G20, to boost the UK’s competitiveness. The government is likely to face renewed demands from the Scottish and Welsh governments for devolved powers to vary the corporation tax on companies resident in their countries, similar to those due to be introduced for Northern Ireland from 2018 (unless this is delayed because of the political impasse in Stormont). The Treasury has consistently resisted the further fragmentation of the corporation tax regime, arguing that Northern Ireland is a special case.
The government will need the approval of the Scottish Parliament and the National Assembly of Wales to secure the passage of the European Union (Withdrawal) Bill. The opposition of the Scottish and Welsh governments to the bill as it stands will give them leverage in negotiating with Westminster. The Northern Ireland executive’s ability to vary the CT rate on its companies is supposed to be contingent upon it demonstrating that its finances are on a sustainable footing. But this could change because of the Tory party’s parliamentary agreement with the DUP. The debate over corporation tax (among other matters!) will resume when the government brings forward a Finance Bill after the summer recess. Expect parliamentary fireworks: the DUP has not promised to support it and the opposition parties have vowed to oppose it.
The bill is designed to create the legal framework for the UK to leave the EU. It is intended to repeal the European Communities Act 1972, which took Britain into Europe, and to incorporate all existing EU laws into the British statute book. In addition, the government may also need to enact up to 15 new bills and between 800 and 1,000 statutory instruments over the next two years. This will reduce the scope for legislation unrelated to Brexit. The bill will give ministers sweeping powers to amend legislation without parliamentary scrutiny. Ministers will not be able to use these powers to impose or increase taxation or to make retrospective provision. The proposal to endow ministers with ‘Henry VIII’ powers to amend provisions, including potentially those relating to workers’ rights and encroaching upon the powers of the devolved administrations, mean that the bill will have a stormy passage through Parliament.
Ministers have conceded that far from saving £350m a week by leaving the EU, as the Leave campaign claimed during the referendum, the UK has financial obligations that would survive its withdrawal from the EU. In its latest report, the OBR has said that while attention has focused on a ‘divorce bill’ (of up to £100bn), this ‘would not pose a big threat to fiscal sustainability. But the government would still have to find the money to pay it. More important are the implications of whatever agreements are reached (or not!) with the EU and other trading partners for long-term growth of the UK economy.’ If leaving the EU leads to recession, higher inflation and interest rates, or lower migration, there is a risk that taxation and borrowing will have to go up even further.
The buoyancy of the British economy in recent years has been largely attributed to rampant consumer spending. It has been fuelled by low interest rates, the easy availability of 0% credit card lending, pension draw-downs and personal contract plans for private vehicles. The Bank of England has started taking steps to mitigate the impact of a rise in interest rates on the banking sector. A rise in interest rates would also adversely affect consumer confidence and spending, by increasing mortgage and loan repayments. It would be difficult for the Treasury to counteract the impact of a credit squeeze on the economy without lowering the VAT rate or cutting other personal taxes, which would reduce tax revenues.
When Britain leaves the EU, businesses will lose access to the reduced withholding tax rates on interest, royalties and dividend distributions that are available under various EU Directives. They are often more beneficial than double taxation treaties to mitigate the burden of withholding taxes. There is a risk that London based banks could lose their financial ‘passport’ (which allows companies in one member state automatically to serve customers in the other 27 without setting up local operations) when the UK leaves the single market. It is being reported that France and Germany are keen to take over the City’s lucrative euro-clearing market for the benefit of their own financial centres after Brexit. They want the EU to force UK operators either to relocate there or to face onerous policing by European regulators, over whom the UK government would have no influence.
To continue servicing their Eurozone clients, UK investment banks have already started leasing property in Paris, Frankfurt and Dublin. This would enable them to move operations and jobs from the City to the EU. It has been estimated that that the City could lose between 30,000 and 100,000 jobs. The Treasury would lose the tax paid by these high paid staff and the corporation tax on the profits from these operations.
The Treasury and business department will be jointly responsible for the government’s formal response to the Taylor review of modern working practices. HMRC will be closely involved in the design of any tax changes. The government may not respond for a while because of its preoccupation with Brexit. It faces the challenge of designing measures that protect workers without stifling the way technology is changing the workplace, given the pride it takes in Britain’s open and technology friendly economy. The Labour party’s opposition to zero hour contracts and the concept of ‘dependent contractors’ means that the government will struggle to secure a consensus. Even if it does, there is no prospect of the measure being legislated for at least two years because of the need to give priority to Brexit legislation. The chancellor isn’t likely to rush to implement the recommendation for greater consistency in the tax and NICs treatment of the employed and self-employed. Following the reaction to the Budget 2017 proposals for increasing the NICs payable by the self-employed, Tory backbenchers have a veto on any such move.
Whitehall is giving the Brexit negotiations and legislation priority in policy development. The establishment of new departments and administrative arrangements, in areas such as trade negotiations, customs and immigration, has added to the pressures on Whitehall when it is struggling to cope with spending cuts. The Treasury and HMRC have established new teams to deal with Brexit and its aftermath, by diverting staff from other work.
The British economy has been in an equally tough spot before. Whitehall will help it to pull through again if the ideological squabbling ceases, and there is united political clarity of leadership about Brexit.
Brexit has intensified the macroeconomic risks facing the economy. The top earners, on whose taxes the Treasury relies, will see lower wage growth; other taxpayers will have to pay more. The government won’t be able to rely on borrowing. Uncertainty about the terms and timing of Britain’s exit from the EU is crippling domestic and foreign direct investment. It will also lead to a loss of City business and staff. This will hurt economic growth. The government’s tax policy priorities include increased taxation, the replacement of the EU VAT and customs regimes, and hopefully greater support for R&D, patent box and innovation.
Sam Mitha CBE believes that the government will have to use tax policy to safeguard the economy and jobs.
UK macroeconomic policy was likely to be dominated by political and economic uncertainty, rising inflation, falling investment, ballooning debt and the spectre of higher taxation, even before Britain voted to leave the European Union. The fiscal outlook isn’t promising, whether Britain makes a graceful exit with a smooth transition (‘implementation phase’) or crashes out of Europe. Brexit will have a profound and continuing effect on the British economy, and on tax policy. If Brexit leads to a sharp contraction in the British economy, the government will have to use tax policy to safeguard the economy and jobs.
The inconclusive result of the recent general election has added to the uncertainty surrounding the outcome of the negotiation process. The economic austerity that began in 2010 under the Coalition government has come to an end. Despite allegedly swingeing cuts to government spending and welfare, the Office for Budget Responsibility (OBR) recently reported: ‘The budget is still in deficit by 2% to 3% of GDP – as it was on the eve of the crisis – and net debt is more than double its pre-crisis share of GDP and not yet falling.’ The Institute for Fiscal Studies has suggested that the UK’s tax burden is set to rise to its highest level for decades because the top 10% of earners, upon whose taxes the Treasury relies, will see lower wage growth following Brexit.
The chancellor has announced a more relaxed approach to eliminating the deficit. The government is now facing demands for increased public spending and the removal of the 1% cap on public sector wage increases. It will have to pay attention because the clamour is coming from its own backbenchers, not just the Opposition or the unions. It will be unable to resist the pressure to loosen its purse strings, because it is vulnerable to even relatively small rebellions from its own MPs. This will result in increased government borrowing and higher taxation. Relying solely on higher borrowing to fund current expenditure is a risky option. It would shift the bill to our children at a time when the Brexit vote, diminishing pension expectations and the difficulties the young face in getting on the property ladder are stoking intergenerational tension.
There is limited scope for further spending cuts, particularly on welfare spending. (The government may find chickens coming home to roost on its earlier cuts in this area.) The government has also ringfenced vast swathes of public expenditure, notably the NHS, defence and foreign aid. The Tory party’s manifesto for the 2017 general election omitted its former pledge not to increase income tax, NICs or VAT (the so-called ‘tax triple-lock’). It promised instead to stick to its plans for corporation tax, keep VAT at the same rate, and simplify the system. The government would have the flexibility to increase income tax and NICs. Whether it chooses to do so is another matter, given that it is in thrall to its own backbenchers and the Democratic Unionist Party (DUP). Most government revenue comes from income tax, NICs, VAT and corporation tax. It could either increase the rates of income tax or NICs or widen the basis on which they are charged, e.g. by taxing all forms of work in the same way. Alternatively, it could raise more money through VAT by exempting fewer items, while keeping the rates unchanged. Any such changes would have political consequences because they would create losers.
Britain’s future economic growth has been adversely affected by the uncertainty about the outcome of the Brexit negotiations. Businesses fear that it would be ‘catastrophic’ for the UK to leave the EU without a deal or if there is a Brexit ‘cliff edge’. The gnawing uncertainty gripping businesses is frightening the ‘animal spirits’ of confidence that motivate investment. Investment is essential for sustaining economic growth. The government’s rhetoric about ‘no deal being preferable to a bad deal’ has led to fears that a breakdown in the negotiations could result in the EU treating the UK as a so-called ‘third country’. This could, for example, lead to the grounding of UK air traffic if it ceased to be covered by the European Open Skies and safety agreements.
Government ministers frequently cite strong jobs growth in the UK as a sign of the strength of the economy. We don’t often hear them talk about productivity, for good reason. Productivity growth slowed in most high income countries following the financial crisis in 2007. But the UK’s slowdown was more severe than elsewhere, and it hasn’t recovered. Since its strong jobs growth comes at a time when economic growth is slowing, it implies that its productivity is worsening. According to the Office for National Statistics, productivity fell below its level of 2007 in the first quarter of 2017. The Nobel laureate Paul Krugman reminded us that while productivity is not everything, in the long run it is almost everything.
The UK has a high employment, low productivity economy because it has a very low level of physical investment (including R&D spending), and a large part of its labour force lacks skills. Higher investment would require a longer term focus on the part of the City, lower personal consumption (i.e. higher savings), and continued openness to the talent from abroad. It remains to be seen whether the introduction of the apprenticeship levy will increase the domestic supply of skilled workers. It wouldn’t be advisable to hold one’s breath. According to the CIPD, the UK already spends more money than most large economies on education, but still lags well behind on literacy, numeracy, digital skills and workplace training. Foreign direct investment has boosted productivity in the UK by importing capital, new technology, modern work practices and skilled managers; foreign-owned firms tend to be more productive than domestic companies. But foreign direct investment into the UK has begun to decline, because investors are concerned about Britain’s loss of access to the single market after Brexit.
Businesses have warned the government about the threat to economic growth resulting from the incipient reduction in the flow of highly skilled inward migration from the EU. Many such workers already here are leaving (or planning to do so) because of the uncertainty about their future rights. Access to the EU workforce has provided the British businesses with a safety valve to mitigate the shortage of skilled workers that has previously constrained British economic growth. Survey evidence suggests that the net inflow of skilled workers has slowed. There has been a less marked decline in the inflow of unskilled EU workers attracted by the national minimum wage and the availability of tax credits. The new French government has begun offering inducements to its 270,000 nationals in the UK to return. Many of them run their own business, or hold well-paid roles. If they leave, the government will lose the tax they directly or indirectly contribute to the exchequer.
The Treasury will come under pressure to use its imminent freedom from the EU’s state aid rules to subsidise British industry. The profitability of UK firms that operate EU-integrated business models will be threatened when Britain leaves the single market and the customs union. Foreign-owned businesses are likely to demand assurances of financial support, similar to those that the government provided to the Japanese automobile manufacturer Nissan last autumn. A better use of its post-Brexit flexibility would be to enhance the relief that the government currently provides for R&D expenditure, patent box and through the business department to innovation centres.
The government has already announced its intention to make administrative changes to R&D tax credits. It could go further, substantially increasing the rate at which relief is currently provided for R&D spending, relaxing the rules on qualifying expenditure, or both. Brexit will also give the Treasury the ability to restore the changes it made to the patent box rules under pressure from the EU. Government support for R&D and innovation delivers a very big bang for its buck. For example, the High Value Manufacturing Catapult, which aims to bridge the ‘valley of death’ between technology ideas and preparing products for the market (‘commercialisation’) delivers £15 for every £1 of government investment. Changes to the R&D and patent box rules would help redress the shortfall between UK investment in R&D (1.7% of gross domestic product) and the OECD average (which is 40% higher). The government should match the kind of support that firms on the continent receive or are likely to receive in the future. For example, Angela Merkel’s party has pledged to raise Germany’s R&D spending as a share of GDP from 3% to 3.5% in 2025 by providing £2bn in tax relief.
The UK is a member of the EU Customs Union. Member states trade freely with each other, but are obliged to charge the same tariff on imports from outside the EU. Customs duties are collected on behalf of the European Commission, and not retained by member states for their own use. Since the UK is intending to negotiate its own trade deals with other countries, it will have to quit the Customs Union. There has been extensive coverage of the difficulties this will create for the ‘soft border’ between Northern Ireland and the Republic of Ireland, and the peace process. There has been less coverage of the impact of the UK failing to reach agreement with the EU to facilitate trade. It would result in existing ports having insufficient facilities and staff to cope with the imposition of new customs inspections, duties, VAT collection, and conformity of goods with EU regulations. It will also result in a fivefold increase in the annual declarations that have to be processed by HMRC’s customs declaration service computer system.
HMRC is undertaking a major upgrade of the system, alongside planning new systems for VAT, alcohol and tobacco warehousing, and databases on trader registers. Its new Customs Declaration Services (CDS) project was commenced before Britain voted to leave the EU. The NAO recently reported that no changes have been made to the CDS programme since then, because of the uncertainty surrounding the outcome of the EU/UK negotiations. It noted that HMRC is actively managing the risks and developing contingency plans. And it has called for the government to do more to help HMRC to mitigate the risk of the system being needed, but not ready in time. The media reports of the NAO’s views paid little regard to HMRC’s track record of delivering major IT projects on time. The recent announcement by ministers that Making Tax Digital will be delayed to 2020 at the earliest for taxes other than VAT will free up capacity within HMRC to deliver CDS. But its ability to do so in time is contingent on the timing and terms of any trade deal with the EU.
Leaving the EU would give the UK the opportunity to retain the current structure of the tax, to change it, or to replace it altogether, e.g. with a consumption or sales tax. It is highly unlikely that the government will make any significant change to the existing structure and rates of VAT. The government will want to safeguard the revenues it receives from the tax, some £115bn in 2015/16. This is second only to what it derives from income tax and NICs.
The Scottish government will take a keen interest in any proposed changes to the VAT regime. It has been entitled to half of the VAT receipts collected in Scotland since April 2017. Leaving the structure of VAT as it is would help to facilitate trade with EU members, and avoid imposing additional burdens on business. The jurisdiction of the Court of Justice of the European Union will end after Brexit, but the UK courts will probably be told to heed the CJEU’s rulings on VAT to maintain legal continuity.
In his spring Budget, the chancellor reiterated the government’s intention to reduce the rate of corporation tax to 17% by 2020, the lowest in the G20, to boost the UK’s competitiveness. The government is likely to face renewed demands from the Scottish and Welsh governments for devolved powers to vary the corporation tax on companies resident in their countries, similar to those due to be introduced for Northern Ireland from 2018 (unless this is delayed because of the political impasse in Stormont). The Treasury has consistently resisted the further fragmentation of the corporation tax regime, arguing that Northern Ireland is a special case.
The government will need the approval of the Scottish Parliament and the National Assembly of Wales to secure the passage of the European Union (Withdrawal) Bill. The opposition of the Scottish and Welsh governments to the bill as it stands will give them leverage in negotiating with Westminster. The Northern Ireland executive’s ability to vary the CT rate on its companies is supposed to be contingent upon it demonstrating that its finances are on a sustainable footing. But this could change because of the Tory party’s parliamentary agreement with the DUP. The debate over corporation tax (among other matters!) will resume when the government brings forward a Finance Bill after the summer recess. Expect parliamentary fireworks: the DUP has not promised to support it and the opposition parties have vowed to oppose it.
The bill is designed to create the legal framework for the UK to leave the EU. It is intended to repeal the European Communities Act 1972, which took Britain into Europe, and to incorporate all existing EU laws into the British statute book. In addition, the government may also need to enact up to 15 new bills and between 800 and 1,000 statutory instruments over the next two years. This will reduce the scope for legislation unrelated to Brexit. The bill will give ministers sweeping powers to amend legislation without parliamentary scrutiny. Ministers will not be able to use these powers to impose or increase taxation or to make retrospective provision. The proposal to endow ministers with ‘Henry VIII’ powers to amend provisions, including potentially those relating to workers’ rights and encroaching upon the powers of the devolved administrations, mean that the bill will have a stormy passage through Parliament.
Ministers have conceded that far from saving £350m a week by leaving the EU, as the Leave campaign claimed during the referendum, the UK has financial obligations that would survive its withdrawal from the EU. In its latest report, the OBR has said that while attention has focused on a ‘divorce bill’ (of up to £100bn), this ‘would not pose a big threat to fiscal sustainability. But the government would still have to find the money to pay it. More important are the implications of whatever agreements are reached (or not!) with the EU and other trading partners for long-term growth of the UK economy.’ If leaving the EU leads to recession, higher inflation and interest rates, or lower migration, there is a risk that taxation and borrowing will have to go up even further.
The buoyancy of the British economy in recent years has been largely attributed to rampant consumer spending. It has been fuelled by low interest rates, the easy availability of 0% credit card lending, pension draw-downs and personal contract plans for private vehicles. The Bank of England has started taking steps to mitigate the impact of a rise in interest rates on the banking sector. A rise in interest rates would also adversely affect consumer confidence and spending, by increasing mortgage and loan repayments. It would be difficult for the Treasury to counteract the impact of a credit squeeze on the economy without lowering the VAT rate or cutting other personal taxes, which would reduce tax revenues.
When Britain leaves the EU, businesses will lose access to the reduced withholding tax rates on interest, royalties and dividend distributions that are available under various EU Directives. They are often more beneficial than double taxation treaties to mitigate the burden of withholding taxes. There is a risk that London based banks could lose their financial ‘passport’ (which allows companies in one member state automatically to serve customers in the other 27 without setting up local operations) when the UK leaves the single market. It is being reported that France and Germany are keen to take over the City’s lucrative euro-clearing market for the benefit of their own financial centres after Brexit. They want the EU to force UK operators either to relocate there or to face onerous policing by European regulators, over whom the UK government would have no influence.
To continue servicing their Eurozone clients, UK investment banks have already started leasing property in Paris, Frankfurt and Dublin. This would enable them to move operations and jobs from the City to the EU. It has been estimated that that the City could lose between 30,000 and 100,000 jobs. The Treasury would lose the tax paid by these high paid staff and the corporation tax on the profits from these operations.
The Treasury and business department will be jointly responsible for the government’s formal response to the Taylor review of modern working practices. HMRC will be closely involved in the design of any tax changes. The government may not respond for a while because of its preoccupation with Brexit. It faces the challenge of designing measures that protect workers without stifling the way technology is changing the workplace, given the pride it takes in Britain’s open and technology friendly economy. The Labour party’s opposition to zero hour contracts and the concept of ‘dependent contractors’ means that the government will struggle to secure a consensus. Even if it does, there is no prospect of the measure being legislated for at least two years because of the need to give priority to Brexit legislation. The chancellor isn’t likely to rush to implement the recommendation for greater consistency in the tax and NICs treatment of the employed and self-employed. Following the reaction to the Budget 2017 proposals for increasing the NICs payable by the self-employed, Tory backbenchers have a veto on any such move.
Whitehall is giving the Brexit negotiations and legislation priority in policy development. The establishment of new departments and administrative arrangements, in areas such as trade negotiations, customs and immigration, has added to the pressures on Whitehall when it is struggling to cope with spending cuts. The Treasury and HMRC have established new teams to deal with Brexit and its aftermath, by diverting staff from other work.
The British economy has been in an equally tough spot before. Whitehall will help it to pull through again if the ideological squabbling ceases, and there is united political clarity of leadership about Brexit.
