The Balancing Act of Tax Reform


The OECD has published its latest report on tax policy reforms, which covers changes that were implemented, legislated or announced in 2016. It looks to identify trends in changes to tax policy amongst OECD members across the globe, with this year's report also including Argentina and South Africa. The key findings show continuing trends for countries to use tax policy to boost growth, while also focusing on reducing inequalities, and driving behavioral change.  

Growth 

Relatively low growth and weak investment is leading governments to focus on tax reforms which encourage investment. The competition between countries for low headline rates of corporate income taxes has been well documented over the last few years and this trend is intensifying again, particularly following President Trump's proposed rate reductions. But with these rate reductions, how does a country balance the books and where will this race to the bottom end?  

Corporate Income Tax

Interestingly, the OECD expects corporate income tax rates to stabilize at an average of between 10 percent and 20 percent for small countries and between 20 percent and 30 percent for larger countries, with the Irish rate of 12.5 percent almost seen as a minimum. Rates lower than this are likely to create political issues. 

One country which is currently out of step with this trend is the U.S., whose top rates of corporate tax exceed 35 percent. However, the new Trump administration has recently revealed plans to reduce the U.S. Federal corporate income tax rate to around 20 percent. If these plans go ahead, we could see more fluctuation in corporate tax rates across the globe. 

While the average statutory corporate tax rate has reduced from 32.2 per cent in 2000 to 24.7 per cent in 2016, the revenues from corporate income tax are not collapsing and these rate reductions have not been mirrored with reductions in corporate tax revenues.

Broadening the Tax Base

Rate reductions usually go hand in hand with a broadening of the tax base to ensure the tax take is balanced and maintained. The OECD has advocated the benefits of having a broad tax base, with rates as low as possible, for some time. The shift away from opaque tax regimes towards more transparent tax systems is, in part, a result of the continued efforts to tackle international tax avoidance under the BEPS initiatives. One such initiative is the country-by-country reporting requirements which have started affecting many multinationals for the first time this year. 

Another base broadening measure is limitations to loss carry forward provisions, which many countries have had in place for some years and the U.K. is in the process of introducing. These provisions are expected to generate 1.3 billion pounds in the U.K. over the next four years. 

Some countries are also developing tax incentives to attract highly skilled and high net worth individuals. Whether we will see this in the U.K. remains to be seen, but with the government so focused on Brexit, and its immigration implications, it is unlikely to be high on the agenda for now. 

There has also been an increased competition between countries for attractive tax incentives on research and development and intellectual property related activities. As more countries introduce such regimes, are we likely to see these reliefs becoming more generous here in the U.K.? Perhaps, but this would be tempered by the BEPS action on harmful tax practices which has already seen changes to the UK patent box regime. 

While property taxes contribute only a small proportion of taxes raised, the OECD broadly recommends that they play an increased role as they usually do not adversely affect growth. The motivation for changes in property taxes varies from country to country, meaning there are no clear trends within this category. These motives include containing the housing market (as the U.K. has done with restrictions to tax relief for buy-to-let landlords and higher stamp taxes on second homes), raising revenue and sometimes even increasing disposable income by lowering rates.

Rate increases in the U.K. were widely criticized by many small businesses earlier this year, which shows that implementing changes to tax policy is not always as easy as following economic theory.

Behavioral Change 

Excise duties were increased in many countries, especially on tobacco products, with the main goals behind these increases being to raise revenue and improve health by reducing consumption. The report notes that the total tax burden on cigarettes is now over 50 percent of consumer prices in almost all OECD countries, and in 10 countries tax makes up 80 percent or more. 

New taxes on e-cigarettes have been introduced in Greece and Finland. As these products continue to increase in popularity, other countries including the U.K. may follow suit. 

The last decade has seen an increase in health-related taxes being introduced on food and non-alcoholic beverages, which is seen with the increasing popularity of taxes on soft drinks, with new taxes and announcements in seven countries, including the so-called “sugar tax” in the U.K. 

Inequalities 

Reforms aimed at reducing inequalities identified within the report have generally focused on reducing personal taxation for low and middle income earners. These measures have the effect of reducing the tax burden on these individuals, but they don't necessarily recoup this tax elsewhere and are broadly expected to reduce the tax take. Therefore, while these measures may increase tax progressivity (the way tax rates increase as the taxable amount increases), the effectiveness of these measures in redistributing wealth is expected to be limited. 

Additionally, while there have been reductions in rates of personal income tax in some countries, social security contributions continue to remain high in many countries.

While reducing inequalities is one of the main drivers for tax policy reform, changes to inheritance taxes generally reduced the tax take, as was the case here in the U.K. However, looking at the detail, some of these reforms were aimed at business succession and job protection, so these changes may be more in line with this objective than they first appear. 

Tax Mix 

In the presentation of the report, David Bradbury, head of tax policy and statistics at the OECD, made a point to explain that corporate taxes are only one method of taxing the owners of capital, as this can either be done within the company, or when profits are distributed to the owners through taxes on dividends and interest. 

As such, the total tax burden on dividend income is made up of taxes at both the corporate level and the personal shareholder level and includes a range of different taxes. 

Although the rates vary from country to country, the report identifies a trend that, since the economic crisis, the total tax burden on dividend income has increased slightly; however, the rates are generally still below those of the pre-crisis levels. With the trend for a reduction of corporate tax rates, this post-crisis increase can mostly be attributed to an increased level of taxation at the shareholder level. 

U.K. tax policy has reflected this shift as, along with reducing corporate tax rates, the historically preferential personal tax rates on dividends have been increased in a bid to make them more consistent with the rates on earnings. This move to increasingly tax income from capital at the shareholder level is expected to have a beneficial impact on both equity and growth. 

Reducing Tax Avoidance 

With all the talk about reducing corporate tax rates, it's easy to forget that most tax take comes from personal income taxes, social security and VAT. 

This is why, in addition to the BEPS initiative for corporates, there is also a global focus on reducing tax avoidance by individuals. Close to 80 billion euros has already been received by countries in unplanned additional revenue as a result of voluntary disclosure programs and other similar initiatives in this area. 

Time will tell whether the U.K. tax base will be sufficiently broadened to allow further reductions in headline rates, but if reforms go ahead in other jurisdictions we could see more movement to ensure the U.K. remains competitive. 

Effect on Growth 

When considering balancing tax rates against the level of tax base, it is also important to remember that the overall tax mix can also affect growth as increases in certain taxes have more of a negative economic impact than others. 

The report explains that the tax policy changes to reduce tax on businesses and income taxes for individuals “is largely positive as corporate and labour income taxes, which have both been identified empirically as the most harmful to growth, are being reduced and, over time, these efforts are being accompanied by a gradual shift towards less economically distortive taxes including VAT, excise duties, property taxes and environmentally related taxes.” 

The government of the day has to balance the potential economic benefit of any changes in tax policy with its need for public approval, but as the U.K. has kept pace with many of the trends identified within the report, perhaps we should expect to see more increases in these taxes which have been identified as less harmful to the economy. 

By Nick Blundell, corporate tax partner at RSM UK.

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