An Excess Profits Tax
The incoming Labour government intends to publish a Roadmap for Business Taxation for the next parliament. With respect to business taxation, its pre-election manifesto was a mixture of the status quo and radical reform.[1] The status quo includes a commitment to cap the main corporation tax rate at 25 per cent and to retain a permanent full expensing system for investment in plant and machinery, as well as a more general commitment to stability. The radical reform includes an intention to replace the business rates system, raising the same revenue but in a “fairer way”. There is also an intention to close loopholes in the windfall tax on oil and gas companies.
The manifesto also said that the new government would seek “an enduring partnership with business to deliver the economic growth we need”. The need for economic growth was spelt out time and again in the election campaign.
Business rates have few, if any, supporters. But the manifesto was silent as to how the approximately £27 billion in revenue collected from business rates could be replaced. HM Treasury’s review of business rates in 2021 introduced specific reforms rather than a full replacement.[2]
The backdrop for any domestic reform is the radical reform taking place in the international taxation of profit for multinational companies. The UK has already implemented the OECD’s Pillar 2 proposal for a global minimum tax (GMT); and stands ready to implement the Pillar 1 proposal to allocate greater taxing rights to the market country in which multinationals makes sales. In the meantime, it has a Digital Services Tax applying to the revenue arising from users of digital services in the UK.
But these international reforms are unlikely to raise anything like enough revenue to replace business rates – or to generate significantly more revenue for a new government anxious to increase spending. So a question that needs to be addressed in the Business Tax Roadmap is whether there are any possible business tax reforms which could raise the considerable revenue required to replace business rates (or used for other purposes), whilst supporting – or at least not hampering - economic growth.
I believe there is one possibility – a new tax on excess profit earned by businesses that sell in the UK. In a Policy Paper I set out how such a tax could operate, and discuss its likely performance.
There are two key features of such an excess profit tax (EPT). The first is that it is designed to fall only on economic rent – a profit over and above the minimum required rate of return on investment (hence a tax on “excess profit” only). This broad approach to taxing excess profit has been advocated by economists for decades – at least since the Meade Committee advocated it in 1978, though the idea is much earlier.[3]
The second main element of the tax is to introduce a VAT-style border adjustment to levy the tax in the market, or “destination”, country: that is imports would be taxed, but exports would not be taxed. This variation of the proposal has also been advocated, as a “destination-based cash flow tax” (DBCFT); for a detailed analysis, see the Oxford International Group’s book, Taxing Profit in a Global Economy.[4]
The Policy Paper sets out the proposal in more detail, drawing on a growing academic literature that assesses the properties of the tax, including its impact on economic efficiency, fairness and issues of implementation.
If implemented on a broad basis, such a tax would have many attractive properties. It would be neutral with respect to business decisions, such as investment and location decisions, since it falls only on economic rent and does so in a location which cannot easily be changed (since it is the location in which customers are located). As such, it should not hamper economic growth. Also, by drawing on the implementation of VAT, the administration of the tax should be relatively straightforward.[5]
The EPT would also be immune to most of the tax planning activities used by multinationals for conventional taxes on profit. Its key anti-avoidance features are that it is collected in the market country, based on transactions with third parties which are readily observable; it does not depend on transfer prices used by the multinational; and it cannot be gamed by locating financial activities or the ownership of intangible assets in low tax jurisdictions.
The original proposal for a DBCFT envisaged that it would replace the existing corporation tax. In principle, that could still be possible within the commitments made by the Labour Party (since the tax includes full expensing, for example). However, that is more problematic with a GMT in place that taxes profit on a source, rather than a destination, basis. I therefore envisage a much more limited EPT, at a relatively low rate, and on top of corporation tax. The revenue raised could help to replace that from business rates, or could enable a reduction in the rate of the existing corporation tax.
As the Policy Paper discusses in more detail, there are several design choices that would be available in introducing an EPT. For example, one choice that affects both the implementation and economic efficiency properties of the EPT is its scope. The benefits claimed above for the EPT apply when applied on a wide basis – including, for example, to all business liable to VAT. However, at the other extreme, the EPT could be applied only to large multinationals – for example, those subject to the GMT. Restricting it in this way would save some costs of implementation since it would only be applied to a relatively small number of large businesses. However, that would also raise technical issues of implementation, discussed in the Policy Paper, and may be less economically efficient, as well as reducing the potential revenue gain.
Notwithstanding the desire for a period of stability in business taxation, the incoming government has the opportunity to consider radical reforms to business taxes that could reduce the extent to which business taxes hinder investment and growth. Theory and evidence suggests that focusing taxes on excess profit in the market country would be beneficial both for revenue and for growth.
[1] Labour Party Manifesto, 2024.
[2] Business Rates Review: Final Report, HM Treasury, 2021.
[3] Meade Committee (1978) "The Structure and Reform of Direct Taxation", report of a committee chaired by Professor J.E. Meade, London: George Allen & Unwin.
[4] Devereux, Michael P., Alan J. Auerbach, Michael Keen, Paul Oosterhuis, Wolfgang Schön, and John Vella, 2021, “Taxing Profit in a Global Economy”, Oxford University Press; see especially Chapter 7. It was proposed also by the President’s Advisory Panel on Federal Tax Reform (2005) “Simple, fair and pro-growth: Proposals to Fix America’s Tax System”, and by the Ways and Means Committee of the House of Representatives (2016), “A Better Way Forward: Our Vision for a Confident America”.
[5] Labour ruled out an increase in the VAT rate, but in my view introducing an EPT is quite different from simply raising the rate of VAT. Implementation choices may also reflect a need to remain compatible with WTO law.