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Why we must increase the tax on debt

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Britain can achieve sustainable economic growth, but we need to reform the tax system, says David Marks

The big economic question (now the banks have been saved) is how to get the country growing and encourage investment. The economic crisis has opened up a debate about what kind of economics we want. Britain can’t rely on the financial sector to drive the recovery and generate growth – a radical strategy is required to reform and modernise the economy to encourage job creation and sustainable growth. Tax reform is centre stage.

Reducing labour costs means companies can employ more people, which helps drive economic growth. Some economists recommend reducing unemployment, which will reduce social security contributions. A radical way to cover the revenue shortfall to HMRC would be to increase the tax on debt.

Deeply embedded in our economic system is an assumption (one that has underpinned taxation policy and the financial markets) that encourages the acquisition of debt; a belief that all borrowing by business is good and should be encouraged through taxation.

Interest payments on corporate debt are tax deductible. It may have been a good idea to encourage businesses to borrow when the result was long-term investment. But in recent years debt has often been used for corporate financial engineering – for example, in a leveraged buyout by a private equity house, or a recapitalisation used to pay dividends to the owners – which delivers a rapid route to personal wealth for private equity fund managers and corporate executives, but can be to the detriment of the businesses concerned.

The relief is mainly exploited by the financial sector and the cost mainly shouldered by UK citizens. The levels of debt financing used in leveraged buy-outs, gearing of hedge funds, and in investment banks results in these businesses often substantially reducing or even eliminating tax payments through the tax deductibility of debt interest. This reduces the UK financial services industry’s contribution to the UK Exchequer.

HMRC income tax and corporation tax revenue records show 75 per cent of revenue is paid by citizens and 25 per cent by corporations - less than 7 per cent by financial corporations and banks.

An immediate cut in the tax relief to financial corporations followed by a gradual cut to non-financial corporations (to avoid transitional difficulties) would raise sufficient additional revenue to stimulate job creation by reducing National Insurance Contributions, lowering the basic rate of income tax, and even reducing corporation tax rates.

We need better targeted tax incentives for long-term business growth, for example by promoting more employee benefit trusts and venture capital, and to encourage investment in infrastructure projects. Increasing the neutrality of the tax treatment of debt-versus-equity would help promote recovery and more rapid economic growth, reduce economic volatility long term and has merits beyond economic growth.

The common good should be reinstated.

  • David Marks is managing director of Marks Barfield Architects. He is a keynote speaker at the RIBA Futures Fair on 2 June
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