Certainty over tax rules is overrated

3rd March, 2012

‘The UK government is so shocked by a bank breaking a promise not to exploit a legal tax loophole that it is introducing retroactive legislation to block it.’

Is that a good idea?

What an unusual question! Most people I’ve spoken to feel the same way about retroactively taxing Barclays as they do about eating oysters – opinion is divided as to whether the concept is wonderful or nauseating and no conscious thought is required.

Yes, yes, we all know you economists are intellectually superior. Answer the question.

The immediate effect – assuming the whole affair doesn’t run through the courts for several years – is to transfer money to ordinary citizens from the employees and shareholders of Barclays. I would guess that this is moving money from richer people to poorer people although I haven’t seen data on that question.

Hurrah for that!

Perhaps. There are more straightforward ways to redistribute but let’s give it a hurrah for the sake of argument. The second-order effect is that banks and perhaps others may expect to pay more tax in future if they stay in the UK, or come to the UK. Some may leave, or decide never to set up here. The long-term effects of this are hard to fathom: businesses like to claim they are very footloose but not all are.

But so far these are just standard arguments for and against raising taxes. What about the retrospective action? Surely that sets an important precedent.

It’s not the first time it’s happened. A famous example is the case of Robert Huitson, a consultant who managed to route his tax affairs through the Isle of Man in such a way as to reduce his tax rate to less than four per cent. This was all legal until the Finance Act of 2008 retroactively outlawed the arrangement. Suddenly Mr Huitson’s legal tax avoidance was declared illegal tax evasion and the taxman promptly asked for more than £100,000 in back taxes. When Mr Huitson went to the High Court, he lost his case. Some 2,500 other tax-avoiders suddenly became tax-evaders, too.

I’m not sure how I feel about that. It seems harsh to retroactively change the rules. On the other hand, why should a well-paid person expect to get away with paying so little tax?

You’ve switched into oyster-eater mode.

Oh, shut up.

The High Court ruled that Mr Huitson’s human rights hadn’t been violated because the government had taken reasonable steps to balance his interests against the public good. In short, it wasn’t just an arbitrary confiscation of his property. But there is disquiet about this kind of thing from commentators, tax professionals and business leaders. The tax expert Professor Anne Redston said after the Huitson case that “as citizens, we have a right to know the legal position before making up our minds.” Jill Kirby, the Conservative Home columnist, called the Barclays affair a “tax grab” that would “lead to uncertainty”.

This creation of uncertainty is a key problem, isn’t it?

Everybody from Adam Smith on seems to think so. I am not so sure. Usually, uncertainty over tax is a problem. Entrepreneurs may be discouraged by the thought that the fruits of their risk-taking and hard work might arbitrarily be confiscated. Similar issues apply to people making any long-term plans. And, of course, frequent tax changes can have these harmful effects even if they are not retroactive.

But few people seem to have recognised that if the entrepreneurial activity in question is avoiding tax through artificial loopholes, it might be a very good idea to generate some uncertainty and give pause for thought. After all, customs officers prefer to search suitcases for heroin in an unpredictable fashion rather than giving advance warning.

That’s very different: heroin is illegal and the uncertainty is about whether you will get caught. We’re talking about uncertainty about whether the activity itself is illegal.

To a jurisprude, I am sure there is all the difference in the world. But I’m just a humble economist and from a pragmatic point of view the two scenarios are quite similar. I am not so worried about retroactive legal changes as such. The real damage would be caused if the authorities were wielding power arbitrarily and picking favourites. In the case of Mr Huitson, the High Court decided that they were not.

Also published at ft.com.

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