Vince Cable this month launched our new publication on helping small and medium sized businesses access stock market finance. Here, I’d like to concentrate on three tax changes that could address the broader challenge of ‘rebalancing the economy’ away from an over-reliance on debt and unproductive investment.
I’m all for a highly progressive tax system that doesn’t privilege ‘capital income’, but that doesn’t mean the current system works in a fair or sensible way, as these three bizarre distortions show.
As George Osborne said in opposition:
Our corporate sector’s excessive dependence on debt is deep rooted in the structure of our economy. In particular, economists have long pointed out that our corporate tax system favours debt financing over equity. Interest costs are fully deductible with very limited restrictions, while the returns on equity receive little or no tax relief.
We should indeed “look again at the generosity of [this] interest deductibility” and the party’s tax policy working group is doing so. But this is not ideal and would kill off many investments that would otherwise go ahead, debt finance being indispensable for many firms. An economically ideal alternative would be to add an equivalent for the cost of equity finance, as is done in Belgium and elsewhere. A revenue-neutral approach, however, may be to partially reduce the debt relief generosity while introducing an equivalent for equity at the same level. We should also look at measures to tackle particular abuses of interest deductibility.
Stamp duty on shares
The UK already has a financial transaction tax in the form of stamp duty on shares. This is a tax with no economic rationale; only that – along with the ‘hat tax’ – it was once the best the taxman could manage.
What’s worse, this transaction tax applies only to certain assets – shares in UK (or UK-listed) companies. This “has helped fuel the market for derivatives contracts, which don’t attract the same tax. […] By promoting trade in share-substitutes, the tax increases “financial leverage and risk””. Whether the aim is higher taxes on UK companies, pensions, ISAs, or ‘bankers’, this is an absurd way to do it.
The reasons why this hasn’t yet been abolished or reduced are simply public perception and possible cost (though Osborne has found money for the poorer choice of corporation tax cuts). In our report, we suggested a cheap, next-best option would be abolition of stamp duty only for smaller, high-growth companies.
Capital Gains Tax (CGT) on shares
I support taxing capital gains at the same rates as labour, provided that we don’t tax the ‘normal’ rate of return. But there’s a strong case that shares should get a preferential rate to take account of corporation tax – just as is done for dividend income.
To illustrate this, imagine someone invests £100 in gold: it gains in value by £50 and they pay, say, 28% CGT on that gain, getting back £136. If they invest in a company and it makes £50 profit, the profit is taxed under corporation tax at 24%, and then the remaining capital gain taxed again at 28%: they get back £127. So – even ignoring stamp duty – an expanding company making exactly the same return as some unproductive asset speculation is made unattractive to investors.
Depending on what broader CGT reforms we opt for, fixing this bias could mean lowering rates for shares (and again we could do this just for small and medium enterprises (SMEs)), or increasing them for second homes and other non-share assets.
It’s not easy to ‘rebalance the economy’ or improve the tax system at a time of budget-tightening and poor growth, but we must rise to the challenge. On this same theme, I hope to write in future about ending the taxation of regular bank account interest and on the favoured investment treatment of real estate. In the meantime, our report looking especially at SME finance is available at centreforum.org.
Originally published at http://www.libdemvoice.org/centreforum-three-tax-changes-to-help-rebalance-the-economy-33384.html