Brown's bogus plan will hit productivity

CHANCELLOR Gordon Brown is threatening 'the biggest reform since 1965'. The intended victims are British companies, which will be taxed differently from now. They endured a shake-up in 1997, when the effective rate of corporation tax was increased by 50%.

If an even bigger reform were truly in the offing, UK companies would be planning to leave these shores in droves. Fortunately, the existence of Bermuda and other places of refuge, should restrain the follies of the Treasury. Nonetheless, to add to the problems of collapsing output and massive pension deficits, UK companies clearly face the prospect of higher taxation.

The principles on which good taxation should be based are clear. The rate should be low and broadly based and it should not distort or damage the economy.

The present system offends heavily on both counts. Its most absurd feature is allowing interest to be deducted as an expense before charging tax. If this were abolished, the same revenue could be produced at around half the current tax rate.

This would have huge advantages. The present system subsidises debt finance at the expense of equity. The result is that companies have too much debt. This is a worldwide problem and is why companies are going bankrupt in vast numbers.

Efforts to avoid corporation tax use a vast amount of brains and effort. If the rate was halved, so would the rewards. Economically useless activity could then be diverted to productive use. If Brown was serious about reform, he would disallow interest and halve the rate of corporation tax. He is not, however, thinking along these lines. His Green Paper is basically an attempt to camouflage tax increases as reform.

Far from wasting less effort on economically useless activities, the proposed changes will make matters worse. The Green Paper admits this. It remarks 'there might therefore be an increase in compliance costs'.

The drive to raise revenue is often blatant. One proposal is to tax capital profits which come merely from inflation. This will distort behaviour. It will raise the cost of making companies more efficient through restructuring their business.

Another proposal designed to raise revenue is to reduce depreciation allowances. This will deter capital investment. Britain already suffers from woefully inadequate investment. One major reason is that the Chancellor raised the effective rate of corporation tax from 20% to 30% when he abolished ACT. The so-called reforms are likely to drive investment down again.

The result of low investment is that productivity improves more slowly. One of Brown's many follies is that he constantly calls for better productivity and makes tax changes which hinder improvement.

A true reform of UK corporation tax would switch resources from tax evasion to improving productivity. The bogus reform we are likely to get will do the opposite. Not only will the results be damaging, they will make real and beneficial reforms more difficult in the future.

www.smithers.co.uk