Tom Clougherty is head of tax and editorial director at the Centre for Policy Studies.
Unless the Government changes course, Britain’s international tax competitiveness is going to plummet in 2023, with coming tax increases set to leave us with one of the least growth-friendly tax systems of any rich nation.
That’s the key finding of a new analysis by the Centre for Policy Studies and Tax Foundation think tanks, based on the latter’s 2021 International Tax Competitiveness Index, which was released earlier this week.
The UK comes 22nd on the latest edition of the Index, just behind Canada (20th) and the United States (21st). We have the best cross-border tax rules of any OECD nation, but do not fare so well domestically: finishing 18th for corporation taxes, 22nd for VAT, 23rd for individual taxes, and 33rd for property taxes.
For now, that ranking is actually slightly unfair to the UK: because of a data lag, this year’s Index does not reflect the impact of the temporary super-deduction for capital investment, which Rishi Sunak announced at his March budget.
The super-deduction addresses a long-standing weakness of the UK tax system – our unusually stingy treatment of business investment – and therefore represents a bold, pro-growth move. If we factor it into the International Tax Competitiveness Index, the UK’s corporate tax rank improves from 18th to 11th and its overall rank from 22nd to 21st.
The problem, of course, is that the super-deduction is only temporary. So while it might encourage firms to bring forward existing investment plans, it is not likely to sustainably boost investment in the longer-run – which ought to be the goal of a truly effective tax reform.
And, sadly, the positive impact of the super-deduction on Britain’s tax competitiveness looks set to be equally short-lived. With higher marginal tax rates due to hit personal incomes in April 2022, and corporate incomes in 2023, the country is approaching a competitiveness cliff-edge. The outlook is not at all promising.
First, the attractiveness of our individual tax system will decline as the ‘health and social care levy’ is introduced. This will increase the top tax rate on earnings to 48.25 per cent, compared with a current OECD average of 42.7 per cent. For dividends, the top rate will rise to 39.25 per cent – the fourth-highest in the OECD, and well above the 24.1 per cent average rate. The UK would fall from 23rd to 31st on the International Tax Competitiveness Index’s ranking of personal tax regimes.
Worse is to come a year later, when the expiry of the super-deduction will be accompanied by a big increase in the headline corporation tax rate, from 19 to 25 per cent. The combined effect of this change will be to send the UK plunging down the tax competitiveness rankings: its corporate tax rank will fall from 11th to 31st out of 37 OECD countries, and it will slide to 30th place in the International Tax Competitiveness Index overall.
This prospect represents a step-change in the UK’s attractiveness to internationally-mobile business and investment. Coming in the wake of Brexit and a deep, pandemic-induced recession, when generating robust economic growth should be at the forefront of every policymaker’s mind, this development ought to be of grave concern to anyone who cares about the prospects of the British economy.
As for the Government, it will struggle to deliver any part of its agenda, whether it’s rising real wages, better public services, or sound public finances – not to mention longer-term goals like levelling up or the transition to Net Zero – if the private-sector economy does not grow strongly in the years ahead. Trashing the country’s tax competitiveness will make that ambition much harder to achieve than it needs to be.
What, then, should we do instead? Nice as it would be, given that tax revenues are forecast to reach their highest sustained level since the aftermath of the second world war, boosting the UK’s tax competitiveness doesn’t necessarily mean cutting the overall tax burden. Famously high-tax Sweden finishes 8th on the International Tax Competitiveness Index – well above the UK – while perennial chart-topper Estonia actually manages to raise an almost identical share of GDP from its tax system as we do.
Rather, the emphasis needs to be on reform – identifying the bits of our tax system that weigh heavily on growth and doing what we can to change them. On corporation tax, that means making the current approach to capital investment permanent, while maintaining a competitive headline tax rate. For individuals, we should rethink the highest ‘additional rate’ of tax, which raises little (if any) money anyway. Property taxes, meanwhile, need a total overhaul – beginning with economically disastrous business rates and stamp duties.
Developing an internationally competitive tax system is one of the key ways the Government can help the UK to attract more business and investment, spur domestic enterprise and entrepreneurship, and generally encourage a dynamic and growing economy. A powerful pro-growth tax agenda is well-within our grasp. We just need the Government to change course before it’s too late. Next week’s budget is the perfect time to start.