A Ten Billion Pound Sized Lie

In the normal world, the world that you and I occupy, you and I and everyone else, income is income and expenditure is expenditure. So if you’re XCo and you project your profits for the next ten years they’ll look, let’s say, like this

Table One

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Over ten years, XCo will have 100 of income, 70 of expenditure and 30 of profits.

Did I say everyone else? I meant everyone else except the Government. What Government does is look at a fixed term, typically five years, and any cash it can shovel into that five year term it treats as income. So if Government devises a legislative measure which enables it to move income in Years 6-10 to Years 1-5 it will treat that income as income of Years 1 to 5.

Let’s assume the Government does this with those tens in Years 6-10 in Table One. You then have a table which looks like this

Table Two

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Over a ten year time frame? Same same. Same income, same expenditure and same profit. But over a five year time frame? Not so much. Profits of 65 – an extra 50.

Accelerating your profits is a bit naughty – even though every little helps – but it’s what the Government does with them that really stinks.

Here’s George Osborne on 2 December 2014 announcing the largest “revenue raising” measure in his Autumn Statement

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And here’s the fiscal impact of that measure (from the so-called ‘Green Book’):

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Take a step back.

If you’re making a profit today, it’s rather nice to have made losses yesterday. You can set them against today’s profits and use them to reduce today’s tax liability. What George Osborne did was to say that instead of using all those losses today, banks would have to share them between today and tomorrow. This means banks pay more tax today – so the Government gets more income today (my Table Two). But over today and tomorrow, the banks pay the same amount of tax and the Government gets the same amount of income (compare with my Table One).

Why does all this matter? Go back to my Table Two. Over Years 1-5 the Government appears to have 50 more of ‘profits’. It uses these ‘profits’ to tell the public it has reduced the deficit. And it ignores the fact that in Years 6-10 it will be 50 worse off. And it has. And it does.

But let’s call this what it is. It’s a lie. In no meaningful sense has the Government brought down the deficit by those five 10s. Or, putting the matter another way, it has brought down the deficit by 50 in Years 1-5 only by increasing the deficit by 50 in Years 6-10.

You should be mightily cross about this. Of all the measures in the Autumn Statement, bank losses restrictions were said to have the biggest yield by far. But the actual yield from the measures is the time value of getting the money early. Which in a low interest rate environment is zero.

And it gets worse.

This isn’t the first time the Coalition has pulled this trick. The biggest ‘yielding’ measure in the 2014 Budget involved an identical sleight of hand. As did the second biggest. Add those three measures together and you have a £10bn sized lie. Told in a single tax year.

27 thoughts on “A Ten Billion Pound Sized Lie

  1. Yes. It’s interesting to look at HMRC’s Information Note

    https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/382332/TIIN_6182_ct_bank_loss_relief.pdf

    that states the policy objective thus:

    ***********
    Policy objective

    Significant losses have been accumulated in the banking sector, a consequence of banks’ performance during the financial crisis and the costs associated with subsequent misconduct and mis-selling scandals.

    The Government considers it inequitable that these losses can now be used to eliminate tax on recovering profits.

    It will therefore restrict the rate at which these losses can be offset against taxable profit, increasing banks’ corporation tax payments during this period of fiscal consolidation.

    ***********

    Now either inequity arises from losses of this kind being used to eliminate tax or it does not. That seems to be a matter of general principle. It is slightly hard to see why inequity would only exist ‘during this period of fiscal consolidation’ rather than at any other time.

    If one concedes the principle of inequity, it might be particularly inequitable in difficult times, but that does not make it equitable at other times. Ordinary people can’t pay less tax because they have had to pay parking tickets or fines for not having TV licences, regardless of the state of the public finances, but in practice that is what the banks can do in relation to the costs of their own ‘scandalous’ behaviour. People might well feel it inequitable for banks to pay less tax to fund public services in any such circumstances.

    However, the measure still allows ALL of these losses to be used to eliminate tax, just over a longer period than would otherwise have been the case.

    Your analysis correctly points out that no more tax ends up being paid overall than it would have been without the measure, and this might prompt some people to wonder whether the policy objective – construed in anything other than the narrowest terms of ‘now’ – is in fact met at all.

  2. It’s also somewhat disingenuous to refer to losses from misconduct and misselling as many of these simply won’t be deductible in computing taxable profits – see the recent McClaren case…

  3. Yes, on the issue of equitability of course fines/punishments aren’t a very good strict equivalent. A better comparison might be someone who turns out not to have paid enough child maintenance – no question that they must compensate for this by making up shortfall out of post-tax income (unless born before 1935!)

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  5. Perhaps an even better analogy might be, well, trading losses?

    It is worth noting that there is SOME value in accelerating tax receipts/ delaying reliefs even in he’s days of very low discount rates. Relief for unusually high employer pension contributions is spread for exactly that reason. It is not accompanied by the pseudo- moralising that George Osborne and HMRC have engaged in.

  6. I would accept that, assuming stable CT rates, there is a yield of the time value of money. If you have negative interest rates or rising corporation tax rates – both distinct possibilities – the real yield of this measure will be negative.

  7. Don’t we already have the bank levy for the very reason that banks have very large accumulated trading losses (ignoring fines, etc, for misconduct), and so would not be paying corporation tax for quite some time?

  8. I’m not making any comment about the wisdom or otherwise of the restriction. I’m just saying that it doesn’t generate the yield the Coalition says it does.

  9. So its cash flow (which the government call profit). Deferral of offset rather than restriction? I assumed that “limiting the amount” meant banks would lose the ability to use 50% of the losses, but you are saying it is just delayed? Presumably someone audits what they say?! Could that explain why there wasn’t more fuss about it?

  10. Yes, yes, yes, yes and no. Strictly speaking what they say is true – the way Govt measures deficit (in a cash basis) means what they say about Ys 1-5 is true. It’s just that Govt is deliberately gaming the stupid way we measure deficit for political gain – ie to tell what, viewed sensibly, is a lie

  11. This is nothing new, all governments of every colour have been gaming/lying like this for as long as I can remember. It’s the nature of politicians whether blue, red, orange or green…

  12. I expect better.

  13. Jolyon

    Whilst I understand what you are getting at, there are a few big advantages for the government in what Osbourne has done – given a couple of caveats.

    Apart from the time value of money effect, which is real but relatively small (I’m guessing), frontloading these payments (by deferring tax losses against future profits) gives much more of an upfront effect on the debt/GDP ratio. Which is probably a good thing given the stance rating agencies have taken.

    As you further say though, this is robbing peter (future) to pay Paul (present).

    It’s not quite as simple as that though. With a positive GDP denominator (GDP growth) future budget deficits will not decrease as quickly, but still look better thanks to this front loading. Likewise, if you assume that Bank profitability will recover, deferring their tax losses will end up making them pay more tax over the long term, though still heavily front loaded.

    As I say, the caveats are continuing GDP growth and bank profitability recovering, but neither is a completely unreasonable assumption. As such, in a purely static case you are correct, but in an evolving case what Osbourne has done is likely to be a net positive to the treasury – even over time.

  14. Hi Tyler,

    Thanks for that. I, of course, was focusing purely on whether it was fair to describe the 10s as yield or reducing the deficit. I think we’re both agreed that they aren’t. As to the time value of money, this is a function (I think) of Government borrowing rates. If these are negative then Government actually takes a hit by getting the money early. It’s also right to note that if rates of corporation tax increase – and there are scenarios in which this is reasonably likely to happen – deferring the use of those tax losses (which are set automatically against profits) until a later moment is likely to increase the value of those losses to the bank and decrease their value to the fisc. So the question whether there’s any real yield is a surprisingly difficult one to answer.

    Not sure I follow your points (in penultimate para) about a positive GDP denominator or banks paying more in the long term… Can you spell them out a little?

    Thanks

    Jolyon

  15. Well, sorry but I assumed “Limiting the amount of profit… that can be offset by losses carried forward to 50%” meant the banks were going to completely lose 50% of the benefit of losses that they could otherwise have carried forward, and I suspect I am not alone. So if this isn’t true, was it a lie or have I just misunderstood? And if I have misunderstood, did the electorate also misunderstand and if so, was it deliberate?

    In the above statement the “£4 bn more” is qualified with “over the next 5 years” and so I wouldn’t call the statement a lie, with that caveat.

    Seems like they need a plain English auditor…

  16. Hi Lydia,

    Re your first paragraph (respectfully) I think you have misunderstood. I don’t think I am qualified to express a view on whether the electorate has misunderstood.

    Re your second paragraph, I think I said (contextualised) that it was not true in any meaningful sense and I’m comfortable with the way I described it.

    Best

    Jolyon

  17. Thanks, I agree I seem to have misunderstood glad I know that now. Not that we do tax for any banks! Yes can see where you’re coming from. Timing is everything, it seems.

  18. Hi Jolyon,

    Sure, no problem. Let’s use a (very) basic example.

    Let’s say GDP is 2000bn, and the budget deficit is 100bn. And use the numbers for “profit” as above in your tables 1 and 2.

    In the zero growth case, assuming also static spending (budget deficit neither decreases or increases from other factors) we can agree that in either case, the accumulated debt stock over 10 years will be 970bn (= 10×100 – 30).

    The budget deficit as a % of GDP will not be the same. For No.1 the budget deficit will always be 4.85%. In case 2 it will be 4.35% for the first 5 years, then increase to 5.35%. So 0.5% lower for the first 5 years then 0.5% higher for the next.

    However, now let us take the case where GDP growth is 2% p.a., and the budget deficit is still 100bn in nominal terms, before bank adjustment – suggesting 0% real spending increases, similar to what the government is currently doing.

    Again, the debt stock over 10 years increases by the same amount for both cases.

    However, if you look at the deficit in debt/GDP terms, No.1 starts with the same 4.85%, dropping to 3.90%. Case No.2 Starts with 4.35% (0.5% better) and finishing with 4.30% (0.4% worse) – with a slightly lower average deficit over the 10 years to boot.

    Pop the numbers into a spreadsheet and play with the variables.

    I would also add that the second order bet is that banks return to profitability long term, so deferred tax losses become less valuable to them (the banks).

    The time value of money aspect also helps the government. Money now is worth a lot more than the same nominal amount in the future – even at low (but +ve) interest rates.

    For example, with discounting off the GBP swap curve, 1bn in 5y time is worth approx. 924m present value, and in 10y time 821m pv.

    It’s financial massaging, but it does make a difference to the all important deficit numbers without the additional benefits of time value and potentially higher tax takes from the banks.

  19. “Jolyon Maugham QC, a leading tax barrister, said: “What’s odd about Ms Westwood’s arrangements is that the rights were held in the UK, but were then transferred out of the UK.” (from The Telegraph).

    Off topic I know, but seriously? You think it’s odd that IP gets transferred abroad? It happens all the time.

    By calling her arrangments ‘odd’ you suggest improper. They are not. The price at which they were transferred would have been subject to transfer pricing review as will the royalty payments themselves.

    Should multi-national groups seek out the country with the highest tax rate they can find and hold their IP there? Or do you think the UK has some ordained right to have IP held and taxed here?

    If you think the arrangements are unsavory you ought to suggest to those that make the laws that they be changed. The laws were not put in place by Ms Westwood.

  20. Hi Andrew, I think you’re rather taking a bit of the quote out of context. The arrangements – transferring IP abroad to LuxCo and then paying a licence fee to LuxCo – are unlikely to be designed otherwise than to achieve a UK tax saving. Which is what I said in the quote. The fact that (at least as you see it) such happens all the time doesn’t mean that the arrangements aren’t tax avoidance.

    Separately you seem to be rather cross with me in light of how you read the quote. That, of course, is your prerogative but I am fairly relaxed that what I have said is both accurate and fair so I’m not quite sure of the source of your irritation… But can I ask this for the future? Either put a reasoned and temperate argument or don’t put anything.

    Jolyon

  21. And let’s not forget the spin around APNs either. Not only is that advancing the receipt, it might have to be returned with interest.

  22. Yep. Linked to those in the blog.

  23. Hi. I think my reasoned and temperate argument was that you had described the arrangements as ‘odd’ which implied at the very least unusual and in the current climate likely to be interpreted by the reader as suggesting improper when they are neither unusual nor improper.

    I suspect virtually every multi-national organisation with IP will be holding it in one place and likely to look for a tax efficient place to put it. Surely that is their perogative?

    I was mildly irritatted but cetainly nowhere near cross. 🙂

  24. Indeed you have. Apologies.

  25. Hi Jolyon

    My comments relate to your original post. In many ways I am extremely disappointed by these Government shenanigans. We have seen a long recent history of accounting ‘errors’ within what passes for standard practice in our capitalist society – from Barings, Enron right through to Tesco.

    The question for me is, is this Government borrowing practice from the private sector? Or is it the other way around? How often have we seen companies banking future profits? Is there something fundamentally wrong with accounting standards and if so does it afflict public and private spheres?

    I recently completed a MBA and the module I did on Finance should have been called Financial Obsfusication! Calling a spade a spade seems out of the question.

    My own accounting experience is around little more than double entry book keeping so I’m no expert. But even a layman has to ask the question ‘Can we trust anything we are told in financial reporting anymore?’.

    My gut feeling is that whatever public and private accounting procedures there are, we need to scrap them and start again and that the principles should be in the concepts of reality and morality.

    Mark Crown

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