Becoming a Tax Haven Is Harder Than It Looks

Slashing rates probably won’t be the U.K.’s magic bullet.

As Britain plans its way out of the European Union, politicians have been looking for ways for the country to maintain its dominance as a center for global capital. One idea: turning the post-Brexit U.K. into a tax haven.

In the frenzied days after the June 23 vote to leave the EU, outgoing Prime Minister David Cameron’s cabinet called for cutting the top corporate tax rate to 15 percent from 20 percent. Cameron’s successor, Theresa May, hasn’t embraced that proposal since taking office on July 13. But with some pro-Brexit members of Parliament calling for the corporate tax to be scrapped altogether, many economists expect the idea to be revisited, at the very least as a bargaining chip to win more favorable terms from the EU.

To finance ministers throughout Europe, tax competition is a worrisome prospect. European leaders have recently agreed on a plan to curtail tax loopholes that cost an estimated $100 billion in lost revenue per year. The EU has already sanctioned Ireland, Luxembourg, and the Netherlands—countries whose permissive tax codes allowed multinationals such as Starbucks, Apple, and Microsoft to shift profits and sidestep tax bills. There is concern that more cooperation within the EU might induce Britain to offer more tax breaks and lower rates, making the rest of Europe less competitive.

It might seem humbling for the U.K. to look to the sort of tax-based economic development tactics used by the Cayman Islands or Bermuda. For evidence of the potential benefits, the British need only glance across the border to Ireland. Since the 1970s, Ireland, where the top corporate tax rate is now 12.5 percent, has used tax discounts to entice businesses.

The strategy has been credited with reviving the economy and building a pharmaceutical and technology sector. U.S. multinationals such as Medtronic have merged with Irish companies in so-called inversions, which shift the official headquarters of a U.S. company, and some assets, overseas.

Economists warn that Ireland’s formula might not work for Britain. In a memo leaked to Reuters shortly after the Brexit vote, Pascal Saint-Amans, the top tax official at the Organisation for Economic Co-operation and Development, wrote that steep tax cuts are usually cost-effective for small countries with relatively undeveloped business sectors. In those countries, the loss in tax revenue is more than offset by new investment. Not so for Britain, which is already expected to be strained by Brexit’s negative impact on growth, Saint-Amans wrote.

An industry in which tax cuts might help is one of the U.K.’s most important: financial services. By leaving the EU, Britain will be free to change some taxes affecting the sector. But if Britain’s cuts are viewed as unfair to other countries, the EU could exact a high price by restricting access to its markets, says Daniel Gros, director of the Centre for European Policy Studies. “After Brexit, EU member states would be able to retaliate and discriminate against any attempt by the U.K. to become a tax haven,” he says.

Given those constraints, the U.K.’s strategy may evolve from taxes to regulations. “The U.K. is not in position to use tax to lure people to relocate,” argues Richard Murphy, a political economist who runs the advocacy group Tax Research U.K. “Previous cuts brought remarkably few jobs. But if the U.K. leaves the EU completely, the real race will be with loosening regulation. There will be an effort to weaken environment and labor and financial regulations.”