Tax Analysts Blog

The Exodus That Wasn't

Posted on Sep 18, 2009

The results are in -- London's hedge funds are staying put despite Prime Minister Gordon Brown's controversial tax hike. That news directly conflicts with all we were told when the U.K. announced it was raising the top individual tax rate from 40% to 50%. The higher rate applies to taxable income in excess of £150,000 per year (about $248,000 at current exchange rates) and bears a resemblance to President Barack Obama's proposal to increase U.S. taxes on those making over $250,000 per year.

The episode underscores a valuable lesson for policymakers around the world who fear their actions could trigger an exodus of local businesses.

Cast your mind back a few months to April 2009. The U.K. budget was just released to the public and news of the big tax hike was met with a chorus of hissing from British financiers who argued that even the slightest increase in their taxes was unacceptable. They warned that such a move would transform downtown London from a thriving metropolis into a dismal ghost town.

The message was clear: If you raise taxes there will be no more banks, no more hedge funds, and no more private equity firms. London's entire financial sector will pick up and leave for the greener pastures in Dubai, Switzerland, or Singapore. And their departure will spell disaster for the residual economy that supports their expensive tastes. Those high street boutiques will shut down because there will be nobody left in the country who can afford £3,000 for a bespoke suit.

Gordon Brown held his ground and raised taxes anyway. He had little choice, really, it was the responsible thing to do. The U.K. government desperately needed the money, and still does. Earlier this year Standard & Poor's threatened to downgrade the U.K.'s credit rating, observing that national debt will soon approach 100% of GDP. To illustrate just how dire their debt crisis is, we note the traditional "golden rule" of British fiscal policy requires that national debt must never exceed 40% of GDP. (Ooops!)

A potential credit downgrade is very serious business. It would trigger an immediate increase in the U.K. government's cost of borrowing, which could bankrupt the country. [Alarmingly, the U.S. long-term fiscal picture is even worse than Britain's. We Americans, regrettably, are the kings of unsustainable debt.]

So what happened in London? Basically nothing. Brown's Labour Party is likely to lose next year's parliamentary elections, but that's been years in the making and is beside the point.

As the Wall Street Journal recently reported, consultancies were swamped over the spring and summer with requests from clients looking to ditch London and move overseas to more accommodating tax environments. After considering the costs and inconveniences of business relocation, however, less than 2% of those client inquiries moved beyond the level of preliminary feasibility studies. In the end, hardly any financial firms have actually moved out of London. It just wasn't worth it.

Yes, there is Dubai -- but it's 120 degrees in the shade and despite the posh shopping malls you're still stuck in the middle of a desert. Yes, there is Zurich -- but it's boring and British bankers don't want to learn German. Yes, there is Singapore -- but do you really want to uproot your family and move halfway around the world? Besides, your kids might get arrested for skateboarding and caned by the police. At the end of the day, it proved much easier for these folks to stay put in London and just deal with the higher taxes. There was a lot of bitching, but the ghost town never materialized.

This is something we should keep in mind the next time the U.S. financial sector -- which we taxpayers just bailed out -- complains about proposals to increase taxes on bank profits or end the favorable treatment of carried interest.

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