Corporate tax incentives for debt finance and ‘very low’ taxes on capital gains may have played a minor role in creating or facilitating the financial crisis, according to the Mirrlees review of the UK’s tax system.
The system is ‘inefficient, overly complex and frequently unfair’, said the authors of what the Institute for Fiscal Studies called the ‘deepest and most far reaching’ analysis in more than 30 years.
‘The tax treatment of housing and financial services, the very low taxes on capital gains, and the incentives in the corporate tax system for debt funding over equity funding are all possible culprits,’ the review’s editorial team wrote in Tax by Design, the second of two volumes published last week. The Mirrlees review’s findings were 'launched' last November.
The review recommended an allowance for corporate equity to ‘align treatment of debt and equity and ensure that only “excess” returns to investment are taxed’.
The idea has been ‘around for a while’, the Financial Times Lex page noted at the weekend. ‘But there are two compelling reasons to now take it beyond the theoretical realm. One is the problems caused by piling on debt in the credit boom. The other is that most big companies are in fact currently flush with cash but do not have the confidence to deploy it. Make using the cash cheaper, and the economics will go some way to overcoming the fear.’
In a chapter on taxing corporate income, the authors noted that the system favoured borrowing over retained profits or new equity as a source of finance, ‘leaving firms more exposed to the risk of bankruptcy’.
They wrote: ‘Borrowing costs are likely to rise as firms become more indebted, and in practice we observe firms using a mix of debt and equity finance. Still, it is unclear why we should want the design of the corporate income tax to encourage companies to have more fragile balance sheets than they would otherwise choose. As a result, more firms are likely to default in an economic downturn than would otherwise be the case.’
The current system imposes ‘unnecessary costs’ on the economy, said Sir James Mirrlees. ‘It reduces employment and earnings more than it needs to. It discourages saving and investment, and distorts the form that they take. It favours corporate debt over equity finance. It fails to deal effectively with either greenhouse gas emissions or road congestion. It could raise as much revenue and achieve as much redistribution as it currently does in far less costly ways.’
Successive governments have failed to set out a coherent strategy for tax, IFS Director Paul Johnson said. ‘A government focused on growth cannot afford to ignore some of the fundamental reforms required to the tax system. That does not mean small gimmicks and one-off allowances; it means a long term, considered and systematic approach to tax policy. This is an approach which has been sadly lacking for many years.’
The review, funded by the Nuffield Foundation and the Economic & Social Research Council, sets out a range of proposals (summarised below) to ‘increase output and welfare’.
Its two volumes are available on the IFS website:
Dimensions of Tax Design (1,347 pages)
Tax by Design (533 pages)
Taxes on earnings
Indirect taxes
Environmental taxes
Taxation of savings and wealth
Business taxes
Source: Tax by Design (Mirrlees review) chapter 20
Corporate tax incentives for debt finance and ‘very low’ taxes on capital gains may have played a minor role in creating or facilitating the financial crisis, according to the Mirrlees review of the UK’s tax system.
The system is ‘inefficient, overly complex and frequently unfair’, said the authors of what the Institute for Fiscal Studies called the ‘deepest and most far reaching’ analysis in more than 30 years.
‘The tax treatment of housing and financial services, the very low taxes on capital gains, and the incentives in the corporate tax system for debt funding over equity funding are all possible culprits,’ the review’s editorial team wrote in Tax by Design, the second of two volumes published last week. The Mirrlees review’s findings were 'launched' last November.
The review recommended an allowance for corporate equity to ‘align treatment of debt and equity and ensure that only “excess” returns to investment are taxed’.
The idea has been ‘around for a while’, the Financial Times Lex page noted at the weekend. ‘But there are two compelling reasons to now take it beyond the theoretical realm. One is the problems caused by piling on debt in the credit boom. The other is that most big companies are in fact currently flush with cash but do not have the confidence to deploy it. Make using the cash cheaper, and the economics will go some way to overcoming the fear.’
In a chapter on taxing corporate income, the authors noted that the system favoured borrowing over retained profits or new equity as a source of finance, ‘leaving firms more exposed to the risk of bankruptcy’.
They wrote: ‘Borrowing costs are likely to rise as firms become more indebted, and in practice we observe firms using a mix of debt and equity finance. Still, it is unclear why we should want the design of the corporate income tax to encourage companies to have more fragile balance sheets than they would otherwise choose. As a result, more firms are likely to default in an economic downturn than would otherwise be the case.’
The current system imposes ‘unnecessary costs’ on the economy, said Sir James Mirrlees. ‘It reduces employment and earnings more than it needs to. It discourages saving and investment, and distorts the form that they take. It favours corporate debt over equity finance. It fails to deal effectively with either greenhouse gas emissions or road congestion. It could raise as much revenue and achieve as much redistribution as it currently does in far less costly ways.’
Successive governments have failed to set out a coherent strategy for tax, IFS Director Paul Johnson said. ‘A government focused on growth cannot afford to ignore some of the fundamental reforms required to the tax system. That does not mean small gimmicks and one-off allowances; it means a long term, considered and systematic approach to tax policy. This is an approach which has been sadly lacking for many years.’
The review, funded by the Nuffield Foundation and the Economic & Social Research Council, sets out a range of proposals (summarised below) to ‘increase output and welfare’.
Its two volumes are available on the IFS website:
Dimensions of Tax Design (1,347 pages)
Tax by Design (533 pages)
Taxes on earnings
Indirect taxes
Environmental taxes
Taxation of savings and wealth
Business taxes
Source: Tax by Design (Mirrlees review) chapter 20
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