Cut Tax to Make Britain a Magnet for the World

The British economy is labouring under a post-crisis hangover and adjusting to a new world of constrained credit and a sustained squeeze on the public sector.

None of the weaknesses identified in successive official reports over the years, whether they be in education and skills, the infrastructure or the country’s capacity for innovation, are getting any better. Inflation is high. In 1997 you could say Britain was a deregulated economy, free of the strangling effect of too much red tape. Nobody would say that now.

These things will take a long time to fix, which is why we should be sceptical of any short-term impact of the government’s plan for growth. Tackling these shortcomings, while essential, will take years.

Are there are any quick fixes? I have written about the urgent need to restore credit growth, particularly to firms. What about an aggressive tax strategy to try to attract activity to Britain? By that I mean cutting the 50% top rate of tax and delivering early on the chancellor’s promise to give Britain the most competitive tax regime in the world.

If such tax cuts could be shown to be at worst revenue-neutral, at best net revenue raisers – admittedly not an easy thing to demonstrate – there would be a powerful case for introducing them even at a time when the public finances are undergoing serious repair.

In the late 1980s and 1990s, Britain’s 40% top rate of income tax shone like a beacon. It spoke of an economy that was “open for business”, an economy that was both flexible and understood the vital contribution made by enterprise. Even when, after 1997, those advantages started to be seriously eroded, the 40% top rate remained.

When it went in April last year, it was a symptom of Britain’s painful loss of competitiveness. This is not just the bleatings of well-off business and City folk.

Today, only a tiny number of countries have a top rate of tax above 50%, notably Denmark, the Netherlands and Sweden. Most are well below it. Britain once had one of the lowest top rates of income tax in Europe. No longer. The eurozone average is 42.4%, the EU average 37.5%.

I wrote in January 2010 about the serious mistake the Labour government was making in raising the top rate, just before the change was introduced (“Tax at 50% is a good way to kill the golden goose”).

As one chief executive told the Times CEO summit: “The biggest challenge we have is the 50% tax rate. There is a massive brain drain taking place that will hit this country for six in the years ahead.”

So, while it was good to hear Lord Mandelson urging an early reduction in the top rate last week, he was part of a government that put it up. And, given there was a Machiavellian political element in the hike from 40% to 50% – an attempt to trap the Tories into opposing it – I doubt very much he was an innocent party.

Under Tony Blair there was a consensus among the two main parties on the 40% rate. That has gone. Any reduction by George Osborne would be opposed by Labour and the Liberal Democrats.

All Ed Miliband could promise last week was no return to the high tax rates of the 1970s (when the top rate was 83% and reached as high as 98% on unearned income). Ed Balls, the shadow chancellor, would bring the threshold at which the 50% top rate kicks in down from £150,000 to £100,000.

In a sense the trap set by Labour worked. Even if the Tories could cope with the flak from Labour and the discomfort of the Lib-Dems, the focus groups and opinion polling that guide government policy would pose a difficulty. When taxes are going up for everybody, how could you justify a cut for internationally mobile business people, even if economically it is the right thing to do?

Perhaps it is indeed politically impossible. All is not, however, entirely lost. In his March budget, the chancellor revealed that he had asked HMRC (Her Majesty’s Revenue & Customs) to review the revenue raised from the 50% rate.

That review will not be ready for a while. HMRC was tasked by Osborne with conducting its review “when the self-assessment forms start coming in”. For many taxpayers, that means after January 31 next year. So even action in next year’s budget will be tight.

The chancellor could of course be brave, and not wait for HMRC’s verdict but that would be a surprise. Even worse, the taxman could conclude that the 50% top rate does bring in net revenue, albeit it not much but enough to make justifying a cut harder. In the meantime, Britain’s international appeal as a location will continue to sink. Can the circle be squared before serious damage is done? I am not sure.

It is not just the top rate of income tax. The reason Ireland has clung to her 12.5% corporation tax rate, despite intense pressure from the rest of the EU, is because it matters.

The government’s planned cut in the main rate of corporation tax to 23% is welcome but hardly revolutionary, merely bringing it down to the current EU average.

The Institute of Directors, in a paper last week, pointed out that corporation tax is but one of many taxes faced by business. For a medium-sized firm, the overall tax rate is 43%. Tax freedom day, the point in the year when such businesses stop working for the government and start working for themselves, is June 6.

High tax stunts growth, for business and individuals. Britain has become a high tax country. As long as that remains the case, growth will continue to be stunted. The golden goose will be well and truly stuffed.

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This post originally appeared at David Smith’s EconomicsUK and is reproduced here with permission.