23 August 2016

As we noted in yesterday’s Daily Shakeup, Swedish Prime Minister Stefan Löfven issued a warning to the UK over the upcoming Brexit negotiations, saying that on the one hand he was open to giving the UK “some time to think about the situation but:

On the other hand, you hear about plans in the U.K. to, for example, lower corporate taxes considerably. If they, during this time, begin that kind of race, that will of course make discussions more difficult.

We heard similar rumblings following the initial suggestion from then Chancellor George Osborne that the UK could cut corporation tax to 15%. That said, it might be seen as a slight surprise that Sweden, traditionally a close ally of the UK on EU matters, is the one issuing the warning on this.

Understandably, the comments drew a rebuke from No 10 and Conservative MPs. Downing Street said:

It’s a matter for member states to set tax policy…Since 2010 the Government has been taking forward measures to reduce corporation tax while in the European Union.

Steve Baker MP, a prominent Brexit campaigner, said:

The UK is entitled to cut corporation tax rates. Of course we need to negotiate in an atmosphere of good faith, but the bottom line is, we’ll set our tax rates, thank you.

How does the UK compare to other EU states on corporate tax?

It’s worth noting how the UK compares to other EU states when it comes to corporate tax rates. As the chart below shows, the UK has far from the lowest corporate tax rate in the EU or amongst countries with some association to the EU. The UK’s rate of 20% comes in just below the EU average of around 22%. If the UK were to cut corporate tax to 15% that would leave it with the fourth lowest corporation tax in the EU. It is also worth noting that in terms of the large economies the UK does have the lowest corporate tax rate by some margin with Germany, France and Italy all having rates around 30%. But it is important to note that this alone does not capture the whole story.

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Firstly, as No 10 rightly points out, corporation tax remains in the purview of EU states and the UK has been steadily reducing its rate over the past decade (see chart below). Germany has also followed a similar path cutting its corporate tax by 10 percentage points, though it remains above the UK’s. Therefore, the UK could have cut corporate tax within the EU if it wanted to; it is not a new power which it is taking advantage of by leaving the EU. The EU has tried on numerous occasions to push ahead with a Common Consolidated Corporate Tax Base but it has always been opposed by a number of countries. Ironically, Sweden is often among them – see for example this opinion from the Swedish Parliament opposing it on subsidiarity grounds.

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But more importantly, the headline tax rates hide a wide array of exemptions and favourable deals which lower the effective corporate tax rates in a number of countries. We are all aware of the tax deals offered by a number of countries to multinationals which the European Commission is now cracking down on. But beyond that, as this list from Deloitte highlights, there are a huge number of exemptions and variations in how corporate tax is levied. Contrary to many countries in the EU, the UK operates a simple system of 20% across the board with no exemptions. This means that the reality of the ‘effective corporate tax rates’ is different to the headline nominal figures. It’s hard to find recent data on this but a study from the Institute of International and European Affairs in 2011 highlighted the issue and found the UK, Germany and Italy have the highest effective corporate tax rates in the EU at around 23%. France was down at 8.2% and Sweden at 16.4%. The OECD has also noted that the effective tax rate on profits for large companies listed on the French CAC40 exchange was around 8%.

Does this tell us much about the upcoming negotiations?

Overall, I don’t think there is much to this dispute. While countries might at times like the idea of greater harmonisation in corporate tax rates the reality is that it will remain under the purview of member states for some time to come – and rightly so. As such, tax competition will remain a feature of policy making in Europe and countries will have to continue to deal with it.

One thing it does highlight is the underlying concern amongst member states that the UK will try to undercut the EU in certain areas once it leaves. This needs to managed carefully – while it does have the potential to sour negotiations it can also be seen as a point of leverage for the UK and will be important in setting the tone of the negotiations and the UK’s new approach to Europe.