It shows, as Richard points out, Osborne's "staggering admission of lack of understanding of how the tax system works." Which is all the more worrying, given that Osborne hopes to get Darling's job – a reasonable hope, given the unpopularity of the current UK government.
Osborne's letter is explicitly about corporation tax and implicitly about tax competition (both of which we've been writing about recently.) Richard explains the arguments clearly, but they are complex and multi-layered. We offer a simplified version here.
Osborne noted that certain companies – Regus, Henderson Group and Charter in this case - are thinking of leaving the UK, citing concerns over the tax environment. The answer, Osborne said, is to cut the corporation tax rate from 28% to 25%. His proposal, if enacted, would be a clear case of tax competition shifting the tax burden away from capital (which means, in practice, the world's wealthier citizens) and towards other forms of tax which hit the poorer sections of society harder.
Several media commentators have written about this: it seems to make sense, they generally conclude. Richard Murphy begs to differ.
"George Osborne has got his arguments completely wrong. For those of us who are UK taxpayers his lack of grasp of this issue is very worrying indeed. It doesn't inspire confidence that this is the man to lead the UK economy through either a time of economic difficulty."
And here is the core of his argument. It's not that complex, really.
The UK, like the United States, taxes companies that are resident in the UK on the basis of a company's worldwide income (giving, of course, tax credits for taxes the company pays in other jurisdictions.) One of the main ways it does this is through Controlled Foreign Company (CFC) legislation: if a UK-resident company controls a foreign subsidiary, then the UK reserves the right to tax that subsidiary.
Now, of course, companies work very hard – with the help of lawyers and Big Four accounting companies – to get around those rules. Sometimes they are very successful, and don't pay much tax. This appears to be the case with Regus, Henderson and Charter, as well as UBM and Shire, two other companies dodging out of the UK for tax reasons which caused some media consternation earlier. These companies haven't been paying very much tax in the UK – and now they are leaving, for tax reasons.
But the question is: why leave for tax reasons if they're not paying much tax anyway?
It's quite simple.
The European Court of Justice has challenged Britain's CFC legislation, and as a result Britain has had to relax it a bit. This will be a bonus for some companies but it will also reduce the overall tax take; so in order for the tax changes to be revenue-neutral overall (which is important), that means the UK needs to tighten up elsewhere. A way it is tightening up is to curtail abusive tax avoidance tricks by companies like the ones we've mentioned.
So they're not leaving because Britain's tax rates are too high. The tax rates don't matter to these particular companies since they pretty much don't pay any tax anyway. They're leaving because Britain is tightening up on their abusive tax gymnastics: under the new rules they will no longer be able to abuse the UK's tax system and they will start to pay tax like the rest of us. Richard continues:
"This has led companies who have not been paying tax in the UK right now, despite being tax resident here, to decide it is time to flee the UK in case under the new rules they will pay tax. No serious taxpayer is leaving: not one so far. And the reason is obvious: for serious taxpayers, many of whom are real companies doing real things and making real money from real activity the existing UK tax structure is already very generous and any change in the CFC rules will be a net advantage to them. You won't hear them saying that, but this is the reality.
So, in that case let's go back to George Osborne. What he's saying is that this so called 'exodus' has something to do with tax rate. It hasn't. It has to do with tax base. He's completely missed the point. . . . he thinks that cutting the tax rate by 3% will mean that these companies will stay. No they won't."
And then he goes on to calculate the cost of Osborne's mistake.
"He would give away 3% on the corporation tax rate to induce companies to stay when the reality is that this will have no bearing on their decision. My research showed that in 2006 the effective tax rate of UK companies was 22% on a downward trend. Let's call that 21% now. Give away 3% out of this and one seventh of the corporation tax yield goes. That is budgeted to be around £50 billion this year (near enough) and that means Osborne's mistake would cost £7 billion. That's some error of misunderstanding."
And, on a somewhat different set of issues, he adds:
"(Osborne) says we should simplify the UK tax laws. Let's be clear: what we're talking about in this whole review is what are in effect anti-avoidance rules. So what happens if we abolish them? Put simply, avoidance will go up. That's what they are there to stop. Why should any Chancellor want to let some people in the economy increase their abuse of the tax rules at cost to the rest of us, especially when that abuse would increase the gap between rich and poor, something Osborne has so recently said to be of concern to him?
All in all it's a staggering admission of lack of understanding of how the tax system works, why it is constructed as it is, what the duty of a Chancellor is and what prospect there might be of sound fiscal management if he took the keys to Number 11."
Finally, what these companies are doing or planning to do is known as "corporate inversion." This definition below is available on the web, which is applicable to the U.S., but is equally applicable to the UK:
"When a U.S. corporation undergoes a corporate inversion, the U.S. corporation becomes a subsidiary of a foreign corporation ("parent") organized in a tax haven country - a country that imposes little or no tax on corporations. The new parent corporation receives income throughout the world, and pays U.S. taxes only on the U.S.-source income generated by its U.S. subsidiary.
In contrast, if the U.S. corporation did not engage in the corporate inversion, income from all sources, whether U.S. or foreign, would be subject to U.S. taxes. The bottom line: By engaging in a corporate conversion, the corporation no longer pays federal income taxes on its foreign source income."
Richard Murphy goes on to describe what might be done about this here.
Today's blog, hopefully, illustrates the complexity of some of these issues, and the pernicous effect of tax competition that allows and indeed encourages companies to undertake such corporate inversions. The British government has quite enough trouble wrangling with these multinationals to pay their share of taxes. Imagine how hard it is for developing countries to face them down on tax. That's why we're so encouraged to see, as we noted here and here, the stirrings of new interest and activism on the part of African and other governments on tax.
The pushback by the poor and vulnerable against the financial wizards and their accomplices has begun. . .