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There's a danger that the political divisions will widen in 2017

Kitty Miv, Editor
08 February, 2016

Kitty's Country Rankings are below, with a description of how they are compiled. This week, as every week, I give out Encomiums to countries which have done Good Things, and award Execrations for countries which according to my highly personal and partial views have done Bad Things.

Tax devolution in the United Kingdom? I told you nothing good would come of it. Especially given the very messy way that the Government has chosen to go about the task at any rate. Scotland hasn't even taken delivery of its shiny new tax power – the Scottish Rate of Income Tax, or SRIT – and already its politicians are talking about reforming it. For its part, the Scottish Labour Party says the Scottish Government should hike the SRIT, which isn't due to be introduced until April, while the Scottish Tories are talking about adding an additional bracket to it before it's even in place. At least Scottish Finance Minister John Swinney has taken the eminently sensible decision to leave SRIT well alone for the time being.

However, people are now starting to appreciate how the SRIT could complicate life for individuals and employers. Indeed, HM Revenue and Customs was accused by professional services firm RSM last month of downplaying the potential impact of the SRIT. RSM said that there is still a widespread lack of awareness of the impending changes among those likely to be affected by them. And for employers, these changes could be quite significant. While it won't be up to them to decide whether an employee receives a new "S" prefix in their tax code or not, they will have to be geared up to withhold Scottish tax regardless of where the company is located. And even if they have just one designated Scottish taxpayer, they'll still need all the relevant administrative systems in place, such as new payroll software, to cope with the new code. So it could be costly.

The "f" word (federal) is usually frowned up by the governing UK Conservatives down in Westminster. But, as the Institute of Economic Affairs suggested recently, maybe it would be better for the UK to go the whole hog, and go federal, rather than persist with a dog's breakfast of a system.

Last week I made the observation that tax credits have become the "go to" tax measure when governments want to achieve certain economic policy objectives. However, running along the rail in a close second place must be tax amnesties. Although, of course, these can only really achieve one thing: a quick revenue fix for governments.

However, it is now widely acknowledged in the academic community that tax amnesties are bad policy because they tend to undermine rates of tax compliance over the long-term. Also, they can be expensive to set up and administer, costs which eat into any new revenue yield. Yet, it seems that barely a week goes by without one tax authority or another announcing the launch of a new tax amnesty, or the results of an existing one. So why do governments persist with them? The only answer I can give to that question is "needs must." Tax amnesty schemes, if designed with just the right balance of carrot and stick, are an easy source of revenue. And given that the horizon of most democratically elected governments is a short-term one anyway – i.e. the next election – then it's easier to understand why amnesties are used, perhaps over-used. But who to execrate? I think it has to be Pakistan, which has just announced its latest in a long line of tax amnesties. It's little wonder hardly anyone in Pakistan appears to pay tax, when they almost have an incentive not to. Thus, Pakistan's low tax-to-GDP ratio will be prolonged.

The naming of Hong Kong as the most economically-free territory in the world by the Heritage Foundation is hardly the story of the century. It is, after all, the 22nd year on the trot that it has scooped this award. Nevertheless, it is the latest in a line of announcements attesting to the SAR's ongoing economic vibrancy. For example, last month, Invest Hong Kong, the territory's inward investment agency, announced that it assisted a record number of businesses to set up or expand in Hong Kong in 2015, a feat its Director General Simon Galpin attributed to Hong Kong's "enduring advantages," which include its low taxes, and its unique situation as the gateway to China. What's more, the latest local incorporation statistics show that the territory continues to buzz with entrepreneurial activity, with almost 1.3m local companies registered under the Companies Ordinance. And the stock market had another impressive year in 2015, when market capitalization exceeded HKD31 trillion (USD4 trillion) for the first time.

Most importantly though, China has no reason to upset Hong Kong's financial apple cart. Indeed, both economies feed off of each other in a symbiotic kind of way. So companies operating in the jurisdiction can be confident that the status quo will be maintained – in fact the Basic Law stipulates that it must, until at least 2047. For these reasons, the "Pearl of the Orient" is awarded this week's first encomium.

Nevertheless, there are reasons to be cautious. While Hong Kong's open economy is a source of strength, it is also cause of weakness; we have seen in the recent past how vulnerable it is to external shocks. When the rest of the world coughs, Hong Kong is almost guaranteed to catch a cold. And the world looks like it's sickening for something at the moment.

What's more, while Hong Kong is very economically free, whether it is politically free is debatable. Actually, recent events have shown that debate is something that Beijing isn't very keen on at all. So while the Occupy Central protestors may have gone home a while ago, discontent with the democratic deficit bubbles beneath the surface. Generally, people resent feeling repressed. Add an economic recession to the mix and you've got a recipe for volatility. It will be interesting to see how Hong Kong's authorities would cope if presented with such a scenario. And how would investors react?

Finally, it would be somewhat remiss of me not to mention the latest battery of anti-corporate tax avoidance proposals from the European Commission, especially as they represent probably the most serious attempt by Brussels so far to harmonize corporate tax in the EU. Indeed, even the most europhile member states in the heart of "old Europe" (France, Germany, Benelux et al) must have been taken by surprise by the ferocity of the Commission's recent attacks on member states' tax regimes. But, rather than do the predictable thing of chastening Brussels for its latest power grab over the tax sovereignty of European nations, I'm going to look at this from a different angle. If there's one good thing to come out of the EU's aggressive stance on tax avoidance, it's that minds are beginning to focus on tax reform on the other side of the Atlantic. Last month, we saw a bipartisan quartet of Senate Finance Committee members urging Treasury Secretary Lew to confront the EU over its state aid investigations, which involve some US multinationals. And more recently, House tax writers emphasized the need for US international tax reform in response to the European Commission's anti-tax avoidance package.

I still think it fairly unlikely that any kind of tax reform bill, be it international, corporate, individual, or comprehensive, will get enacted this year. Even if the matter is being viewed with increasing urgency on both sides of the congressional aisle, there probably just isn't enough time to get it agreed. The House of Representatives is in session for less than a third of the year in 2016, which is also an election year.

On the other hand, maybe it really is now or never. Imagine President Bernie Sanders trying to work with a Republican Congress on the economy. Or Donald Trump trying to convince Senate Democrats on tax and immigration reform. There's a danger that the political divisions will widen in 2017, rather than heal. And that's likely to spell paralysis rather than progress.


Kitty's Encomiums and Execrations

Methodology: each week (this is the 147th) one or more countries are given encomiums and one or more are given execrations. Those are the entries below with descriptive links. In the following week, each encomium counts as + 1 for that country, and each execration counts as – 1, being added to that country's existing score. Over time, therefore, a ranking will build up for each country, and further countries will join the listing. Germany is at minus 2, since in the second week it had an execration and in the first week it had an encomium, leaving it at neutral; then it had an execration in week four, thus dropping to – 1, and another one in week six, dropping to – 2; finally in week 13 it got something right, so it went back up to – 1; then in week 16 it gained a further star, so then it was in neutral territory until week 23 when it dropped back to minus one, but reverting to neutral territory in the following week, then dropping to minus one in week 50, and back up to plus one in week 51, then to plus two in week 52. Some weeks ago it dropped a place, but then quickly recovered one step. Etc etc.

The rankings are intended to be a proxy for business friendliness; evidently they are highly partisan, but as time goes by they are becoming useful for decision-making. For any country in negative territory, you should think carefully before starting a business there.

Kitty's Encomiums

Hong Kong shines

United States focuses

Kitty's Execrations

United Kingdom messy

Pakistan shamnesty



About the Author

Kitty Miv, Editor

Kitty was born in Argentina in 1960 to a Scottish cattle rancher and his Argentine wife. Educated in Edinburgh and at Princeton, Kitty worked for the World Bank as an economist, where she met and married an emigre Iranian banker. During her time with the Bank, Kitty worked in a number of emerging markets, including a spell in the ex-USSR as a Transition Economies Team Leader. Kitty is now a consultant in Brussels and has free-lance writing relationships with a number of prominent economic publications. kitty@lowtax.net


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