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  • Stuart Fowler

The Laffer Curve and the taxation of non-doms


In a week that saw outbursts at the idea of Shariah law operating in parallel to English law, it was ironic to see similar outbursts at the draft legislation (promised in the pre-budget report) to change the parallel laws already governing the taxation of people resident in the UK but with non-UK domicile or country of origin (so-called ‘non-doms’). Labour has referred to its intentions to make the contribution these people make to the Exchequer ‘fairer’ in every budget speech for six years and was finally goaded into action by a Conservative proposal to make non-doms pay a levy of £25,000 per annum to keep their parallel taxation system. This taxes only income and gains directly arising in the UK and foreign income actually remitted to the UK. Labour’s pre-budget initiative proposed a levy of £30,000. The devil was always going to be in the detail and that is why it is only with the draft legislation that we are starting to hear threats of a mass exodus of affluent foreign workers.

In matters of taxation, I prefer to see the optimal methods and rates in terms of rational, economic utility: fairness is far too charged, much like the integration of ethnic minorities. The simplest benchmark is the Laffer Curve, promoted by US economist Art Laffer, that had played so well to the love of homespun domestic economics shared by Margaret Thatcher and Ronald Reagan. At a tax rate of zero, says Laffer, the revenue raised will be zero. But at a tax rate of 100% the take will also be zero as economic activity then has no sustaining purpose. Somewhere in between is the tax rate that is optimal, as it maximises the sustainable tax take for present and future generations. So the question for the current debate is simply this: was the tax burden on non-doms sub-optimal and have both parties broadly got it right with their similar initiatives?

The proposals I don’t want to go into detail because a web search for non-doms off this site will reveal this. The essential principle is that non-doms who have been resident (itself subject to some minor definitional changes) in the UK for seven out of the last nine tax years will either pay tax on the same basis as people who are both resident and domiciled in the UK or they may (in each tax year) opt to pay £30,000 per spouse to opt out of the UK regime and be taxed only on their UK source income and gains and remittances from abroad.

The definition of the latter has been tightened considerably in ways not evident until the draft legislation, the purpose of which is rational (and some would say fair). The old separation between remitting income and remitting capital left the remittance system wide open to simple and cheap constructs to minimise taxation on money brought into the country. The new basis will look at the original source of the money, which could be either historic income or historic realised gains or a mixture. This proposal has raised howls of anguish about ‘retrospective legislation’ because it looks back to earlier tax years and ‘unworkable complexity’ because of the accounting challenge (and costs). But without it the remittance basis is a sham as it is too easy to bring in a capital sum, financial assets or fungible chattels (such as a work of art) to fund UK income needs for many years.

Opting to pay the levy will also deprive non-doms of the benefit of UK allowances against their UK-chargeable income and gains.

An unintended complication affecting responses to the legislation is the decision of the US government not to treat the £30,000 levy as foreign tax. Not being a tax charge, it will not be treated as a tax credit when applying the double-taxation treaty to its taxation of US citizens’ foreign income. I am not sure how many other countries will take the same view although in many cases of UK-resident non-doms double taxation treaties do not exist or the taxation of their domicile is low or non-existant.

Determining the impact The Laffer Curve will apply in this case. One of our largest communities of wealthy non-doms used to be Greek shipping families. They left in droves but not in response to changes in UK taxation but when the Greek Government lowered tax rates to tempt them back home, where they probably preferred to live.

I suspect it will never be possible, even with hindsight, to isolate the impact of this new change in relative taxation because of the economic context in which it takes effect. Discussing this with a couple of banking wives (one Greek, hence the Greek tale above, one Italian), they were alert to the possibility that the jobs that brought their husbands here may not remain. I probably spoilt their dinner by pointing out that in the 1973/4 bear market the number of jobs in London Stock Exchange member firms fell by 25% but I would not have mentioned it had they not already shown realistic concern. This probable downcycle in financial services might be taken as a reason for not disturbing the non-dom tax regime now but it will probably make little actual difference if the elites (and their incomes) in financial services are shrinking anyway.

Even without taking the economic context into account, we can speculate about possible impact. The impression given by the Government that this was a knee-jerk political response to the Conservatives Conference speech shortly before is probably misleading. There has been debate, consultation and lobbying between officials and tax lawyers about this for a long time, although it is also fair to say that the lawyers were inclined to the view that no politician would have the courage to take a chance on the tax take effects. The fact is that we do not really know until we try. In my judgement, it has always looked worth a try and I was quick to applaud the Government’s courage, even if partly goaded by the Opposition.

Sticky families My own family has non-dom issues in conjunction with US domicile. Leaving is not an option and it is simply a matter of calculation of relative advantage between two alternatives. Many non-domiciled wives of UK resident and domiciled husbands (and vice versa) will approach the decision in the same way.

Amongst our No Monkey Business clients (hardly a representative sample) we see similar instances of attachment to the UK which in purely financial terms is sub-optimal. Those who have chosen to change their residence are marked by non-financial preferences, such as the absence of ties to children.

Some UK-resident and domiciled families with entrepreneurial activity effectively spread between the UK and foreign jurisdictions (such as managers of offshore investment funds) have already made the decision for similar reasons to remain UK-resident and remit sufficient foreign earnings to prevent a tax enquiry into the geographical division of their income.

Doubtful families Many non-doms are like my foreign dinner companions last week: they have a quality of life in the UK that is already weighted far more heavily in their calculations of personal utility than maximising net income or wealth accumulation. The occasion was a school fund raising and education and environment for their children is a critical consideration.

There must be a point at which relative financial advantage is too high a price, consistent with the Laffer Curve. But that point depends critically on how they are taxed elsewhere. If they would otherwise be taxed on worldwide income (as US and many other citizens are) and enjoy the benefit of a double taxation treaty, the tax impact is limited to the differential between the higher and lower of two regimes (the higher rate and lower allowances are the ones that bite). Many of the high-earning service workers fall into these categories. I believe the vast majority will either go where their employers send them or elect to stay as long as they can and pay the lowest of the two options after calculating the combined worldwide tax rate.

In this very large category, the impact on the actual tax take here and at home is a function of geographical balances (particularly of unearned and previously unremitted foreign income and realised gains) that are impossible for HMRC to anticipate – and I can’t either. But neither do they matter much if the relative advantage is fairly small.

Footloose families Who is most at risk is easily spotted: families whose economic activities do not tie them to the UK and whose country of origin is not (and would not otherwise be) taxing them – or taxing them heavily. This includes those escaping the monsoon or Ramadan and who, much as they might prefer London, could decamp to an alternative that provides similar calendar- and climate-related advantage. I suspect the Treasury’s thinking is that these lightly-taxed globe-trotters are the key subset where the tax changes either work or fail. These families will have to pay more if they want to stay. But if they decamp, their economic loss (mainly measured in small-scale employment and VAT) does not look great.

Who’s missing? Why, the entrepreneurs of course – a subset of the same people who are up in arms about the changes in the CGT business taper relief rules, except also having the characteristic of being of foreign domicile.

Entrepreneurs are different from the salaried (or bonused) service professionals who make up the vast majority of non-doms with economic activity in the UK. But they are different only if the utilities they are seeking to maximise involve a different set of financial attributes or social attributes. I assume the social factors they value are esentially the same, although there may be some (such as personal safety and corruption in the host economic system) that are somewhat specific to being a wealthy business-owner.

The financial factors vary mainly because they are partly specific to the UK’s corporate tax as well as the personal tax regime. In corporate taxation, the Laffer Curve has always been at work, biting largely on relative advantage between competing host countries. The notion that the underlying principles are really economic, rather than fairness, also applies in the competition for entrepreneurial activity.

How much (and how differently) the corporate and personal tax regimes will affect this category of non-doms is also very difficult for the Treasury to anticipate. It might take the view that the key decisions have already been made: to locate it here on corporate tax advantage, live where the business is or try to run it from a distance observing the non-resident rules.

Conclusions Put like this, you might decide there is much less evidence of either great gain or loss to the Exchequer and therefore the whole exercise is not worth the effort, cost or uncertainty. But I think the proposals are likely to work to the national advantage and that we have been more generous to foreign workers and non-dom marriages than we ever needed to be. In the end it’s just a political judgement. But the Government having made its choice, as it has for CGT, I would be disappointed to see it cave in to threats from small elites, however noisy and well-represented. Finding the optimal point on the Laffer Curve has always involved calling bluffs.

#taxation

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