Strange as it may seem, there was a time when George Osborne was considered a tax radical. It was, of course, from the safety of the opposition benches, but he did once exhibit evidence of a reformist zeal.
Since he moved in to No 11, there have even been the occasional hints that the old Mr Osborne is dormant rather than extinct. Establishing the Office for Tax Simplification, abolishing stamp duty on AIM-quoted shares, last March’s pension annuities shake-up and December’s overhaul of residential stamp duty were all bold policies.
There is one area, though, where he could make huge changes to the economic foundations — and it’s a reform for which he has already expressed sympathy. Overhauling tax relief on debt interest. At present, the tax system is set up to encourage business to load up on debt. As interest payments can be offset against profits, companies can lower their corporation tax bill simply by leveraging up. Equity investment gets no such advantage. After the 2008 financial crisis, this “debt bias” came under intense scrutiny and the following year Mr Osborne decided it was an area in desperate need of reform.
“The UK is widely regarded as having the most generous tax treatment of debt interest of any major economy,” he said. “The time has come to look again at the generosity of interest deductibility in our corporate tax system.”
Since then, nothing. Once in government, he ran up against the state machine. A 2010 Treasury paper on corporate tax decreed that “the UK’s current interest rules are considered a competitive advantage”. The UK, it turns out, quite enjoys its status as a tax haven.
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At next Wednesday’s budget, though, the chancellor has a rare opportunity. With no party expected to win a majority in May’s election, he is in the unusual position of being both in government and out of it simultaneously. This should be an aspirational budget, just such a moment to announce a difficult review into debt interest.
By offering unlimited relief, Britain is an outlier in Europe. In Germany, companies can offset just 30 per cent of profits against interest if borrowing costs top €3 million, although the remaining entitlement can be rolled over to the following year. Denmark is more severe. Last year, France decreed that a company would lose a quarter of any interest relief above €3 million.
At the same time, the OECD is reviewing arrangements that allow multinationals to raise debt in one country and transfer it internally to spend in another.
If a little of the chancellor’s 2009 spirit remains, he should unveil plans for an “allowance for corporate equity”, as advocated by the Mirrlees review — the benchmark for sensible tax policy. An Ace would work by allowing companies to offset annual equity investments against profits in the same way interest is deducted. A full Ace would be unaffordable, costing an estimated £8 billion a year. By setting a German-style deductability cap, though, the chancellor could fund a small one.
Mr Osborne has form here. In December, he said that banks would be able to offset only half of their accumulated losses against profits annually — similar to Germany’s interest cap. At the same time, he pre-empted OECD tax changes by introducing a “Google tax”. He might similarly anticipate OECD rules to limit interest tax relief.
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Economically, it makes sense. Encouraging equity investment would help small firms and deterring leverage would prevent corporate balance sheets getting fragile.
The only big victims would be private equity, whose business models are built on debt. And picking on supposed “asset strippers” who famously pay a lower rate of income tax than their cleaners would not be such bad politics, either.
Philip Aldrick is Economics Editor of The Times