Public finance priorities: A view from the UK-based financial and related professional services industry

Submission ahead of the 2020 Comprehensive Spending Review

 Introduction and context

  1. TheCityUK is the industry-led body representing UK-based financial and related professional services. The industry contributes over 10% of the UK’s total economic output and employs more than 2.3 million people, with two-thirds of these jobs outside London. It is the UK’s largest taxpayer, with financial services contributing £75.5bn in annual tax revenue. The industry also plays an important day-to-day role in the lives of individuals and the operations of businesses.

  2. The economic recession triggered by Covid-19 and subsequent public-health policies, as well as significant and ongoing policy uncertainty, present extreme challenges to the UK government. Real GDP declined by 2.2% in Q1 2020 and 20.4% in Q2 2020.[1] The UK’s economic contraction is expected to be 10-15% year on year in 2020, according to our survey of multilateral forecasters and leading economic think tanks.[2] The speed and profile of the recovery is highly uncertain given that globally the pandemic shows no sign yet of abating. Expectations are that it will be years before economic activity recovers to match pre-pandemic levels, much less exceed them.

  3. This unprecedented economic disruption will weigh heavily on the public finances. The cost of fiscal measures implemented in response to Covid-19 pushed public sector net debt above £2trn at the end of July 2020, equivalent to 100.5% of GDP. Public sector net borrowing was £150.5bn during the period April–July 2020, compared to £22.1bn in the same period last year.[3] Borrowing is expected to continue to rise in the months ahead; moreover, short- and medium-term fiscal risks are significant and are on the downside. For example, if a new economic and trade relationship is not agreed with the EU to cover the period following the end of the transition period on 31 December, economic growth in 2021 would likely be even slower than currently forecast, which in turn would result in lower-than-forecast tax revenues, and higher government borrowing and debt. In addition, current forecasts for economic growth are based on the assumption that there is no resurgence of Covid-19 and that social distancing measures continue to be eased. However, if the public health situation continues to worsen and if there are further localised lockdowns, economic growth will be slower than currently forecast. This will again lower tax revenues and possibly increase public spending and borrowing.

  4. Government spending has been crucial in mitigating the worst economic effects of the pandemic, and the government may have to spend even more than initially expected in order to protect jobs and businesses even without a significant second wave of infections. The urgency of crisis-oriented spending must be balanced against the need to maintain a responsible fiscal policy. Notwithstanding all this, the UK will continue to face profound choices about public spending priorities. Government spending in the coming months must support not just near-term crisis-relief measures, but also areas whose strength will ensure the UK’s continued economic competitiveness in an increasingly difficult global environment. The financial and related professional services industry is keen to ensure that it can continue to maximise its direct and indirect contribution to the UK economy, and in this context, we offer the following proposals:

    • target measures which prioritise economic growth that is sustainable over the long term, help create well-paid jobs, and further the UK’s progress towards its international commitments on combating climate change

    • consider reforms which could increase the industry’s economic activity in the UK, which in turn would lead to a boost in overall tax revenues

    • consider an alternative framework for recapitalisation of corporate debt to avoid a worst-case scenario of widespread business liquidations and job losses

    • ensure that further devolution extends and enhances local decision-making, and widens the toolkit of local leaders to empower areas and drive recovery; extend devolution deals to strategically important towns and cities, and where these already exist, ensure that local leaders have a greater ability to affect change

    • strengthen the UK’s place in the world as a safe and predictable place to do business, a welcoming destination for inward investment, and a globally competitive provider of goods and services

    • engage in a more proactive and coordinated way across government departments engaging with international commercial issues, and invest in those parts of government not yet attuned to commercial priorities

    • invest further in the UK’s global network of Embassies, High Commissions and Multilateral Missions

    • cater for global developments in tax policies and the international labour market; prioritise international cooperation to ensure the UK can continue to attract inward investment, lead the fight against tax evasion and minimise complexity arising from market fragmentation

    • consider how to overcome issues likely to arise from an increase in cross-jurisdiction remote working, such as worker tax residency, company residence, and permanent establishment.

    Details of these proposals are set out below.

    Strengthening the UK’s economic recovery

  5. The UK-based financial and related professional services industry’s tax contribution sits above the headline rate of corporation tax. Its contribution accounts for £11 of every £100 of tax paid to the exchequer; the banking industry alone contributed £39.7bn in tax in 2019, comprising corporation tax, business rates, employment taxes, irrecoverable VAT, the bank levy and the bank surcharge. Many of these taxes are not dependent on profits, meaning that firms pay regardless of how well their business is doing. Tax paid by firms is only one element of the industry’s total contribution; the economic activity generated by the industry also leads to a significant tax contribution. The government should learn from the experience of the 2008-09 global financial crisis and be mindful not to attempt to rebuild public finances too quickly. Raising taxes and/or reducing public spending too aggressively now would be both premature and counter-productive. It would suppress already fragile consumer demand, and prolong and deepen business vulnerability, thus harming growth and tax revenue prospects. But to ensure that the eventual fiscal consolidation is not brought about by overly aggressive cuts to public spending, government should target measures which prioritise economic growth that is sustainable over the long term, help create well-paid jobs, and further the UK’s progress towards its international commitments on combating climate change. Positive actions that the government could take now include ensuring incentive structures are stimulating investment in the right way. This would help support the growth and create the jobs needed in the coming years, as well as provide additional tax revenue for the Exchequer. Any stimulus needs to be attuned to present circumstances. For instance, five years ago a European Commission report (2015) concluded that venture capital and angel investment generated positive macroeconomic effects such as job creation and productivity gains. But recent industry research suggests that external equity funding to fast-growing businesses fell by approximately 40% in Q2 2020 year on year and predicts an overall drop of £6bn of funding throughout 2020.

  6. The UK will always have an international place as a manufacturer and exporter of goods. But future UK global competitiveness will lie in trade and investment in high value-added services. It will be vital to ensure the UK continues to be an attractive place for inward investment and for the financial and related professional services industry to carry on international business in a post-Brexit environment. Thought must be given to reforms which could increase the industry’s economic activity in the UK, which in turn will lead to a boost to overall tax revenues. A good example of work that is already underway is the HM Treasury review of the UK funds industry. The UK is a leading asset management centre and it is vital that all components of the value chain can be located here. Regions across the UK benefit from employment opportunities offered by the sector and increased levels of activity will bolster overall levels of tax paid by the industry. TheCityUK responded to HM Treasury’s recent consultation on the tax treatment of asset holding companies in alternative fund structures and put forward suggestions as to how to the UK can capitalise on this opportunity.

  7. The rapid response by government and industry in the form of the Covid-19 business support loans, VAT and business rate deferrals, and the furlough scheme, have all been essential in helping companies survive the initial economic impact of the pandemic. Early indications show that these interventions saved jobs, minimised broader economic harm, and laid the foundations for a stronger economic recovery than would have been possible otherwise. However, as we look forward, it is clear that many businesses will need help to tackle a debt burden that could hold them back or drag them under. We believe that some of the debt taken on by firms in recent months will ultimately prove to be unsustainable.

  8. The amount of unsustainable debt will be considerably larger than the private-sector’s capacity to refinance it. TheCityUK, supported by EY, estimates that the total unsustainable business debt expected by March 2021 will be c.£67-70bn[4]. As much as c.£20-23bn of this unsustainable debt is expected to stem from government-guaranteed lending schemes (BBLS, CBILs CLBILS). As things stand, if businesses cannot service this debt, lenders would be forced to proceed with insolvency procedures to attempt to recover the debts, and if this is not possible, trigger the government guarantees to recover their capital. Borrowing firms would mostly be forced into liquidation, employees laid off, and the taxpayer could face both the indirect cost of the guaranteed debt and the direct cost of a significantly higher unemployment rate.

  9. Under the auspices of TheCityUK’s Recapitalisation Group, supported by EY, we therefore offer an alternative framework as a way to try to avoid that worst-case scenario. With a view to two types of firm—viable businesses that need capital to repay debt, and viable businesses that can repay debt but need capital to relaunch and grow—we recommend the following:

    • For businesses that need capital to repay debt: a Business Repayment Plan in which a government loan (BBLS or CBILS) is converted to a tax obligation that the business repays out of taxable profits or some other measure of business recovery, alongside its tax payments.

    • For businesses that need capital to repay debt: a Business Recovery Capital plan, in which a government CBILS loan is converted to subordinated debt or preference shares, with a longer fixed term.

    • For businesses that need growth capital: a Growth Shares for Business plan, with equity investment into Small and Medium sized UK businesses in the form of patient or growth capital.

    Full details of these proposals are in our recent research[5], and we would be pleased to discuss this in more detail and stand ready to help HM Treasury wherever possible.

  10. The stated ambition of the government even before the onset of the pandemic was to ‘level-up’ the UK. Re-affirmed by ministers in the aftermath of the pandemic, it has the potential to be an even greater, defining tenet of government policy and a guiding principle of the UK’s recovery. Indeed, it is arguably all the more urgent now that the pandemic and ensuing recession has real potential to deepen existing regional inequalities. In the current challenging circumstances, long-standing approaches to investment, partnerships and decision-making may need to be refreshed, if not re-thought. Location-based plans–including devolved settlements and local industrial strategies–should encompass levers to improve skills, infrastructure, connectivity and collaboration, which have long been industry priorities that echo across the regional ecosystem. The industry is ready to support central and local government in the delivery of these place-based strategies that can drive regional growth in every area of the UK. Working in partnership with local leaders, major priorities include building skills pipelines, boosting local connectivity and making sustainable investments. Furthermore, in every area of the UK, the sector can also provide answers to emerging challenges, with solutions that enable new behaviours, technology that harnesses innovation and services that empower citizens.

  11. Financial and related professional services clusters across the UK are well-placed to act as the engines for restarting and rebuilding the economy. Major UK centres with more than 30,000 in employment in the industry include Birmingham, Bristol, Edinburgh, Glasgow, Leeds and Manchester. Overall, 22 towns and cities in the UK each have clusters of more than 10,000 people in employment in financial and related professional services. But where there are significant aggregations of people and businesses across the UK, they require effective local and regional representation, leadership and powers. For different locations to recover from the pandemic, and meet the wider levelling-up challenge, they need the right tools at their disposal. Some already have regional leaders and decision-making bodies in place. Others have not yet benefitted from the sense of location that devolution can deliver. We therefore recommend that further devolution should extend and enhance local decision-making, and widen the toolkit of local leaders to empower areas and drive recovery. By setting parameters and identifying local themes and challenges for which partnerships can be established and interventions can be set in train, different locations in the UK can be positioned at the vanguard of the recovery and the wider efforts to rebalance the country. In its forthcoming Devolution White Paper, government must therefore extend devolution deals to strategically important towns and cities, and where these already exist, ensure that local leaders have a greater ability to affect change.

    Strengthening the UK’s place in the world

  12. Matching domestic policies to strengthen the UK’s economic recovery, there needs to be measures to strengthen the UK’s place in the world as a safe and predictable place to do business, a welcoming destination for inward investment, and a globally competitive provider of goods and services. Much of this falls to businesses in the private sector. But well-planned supportive government policies and programmes are also essential.

  13. In order to deliver greater value to government initiatives overseas, it is vital that the government follows a joined-up approach. It should engage in a more proactive and coordinated way across departments engaging with international commercial issues (for example, DIT, FCDO, HMT, BEIS, MoJ and DCMS, as well as the Home Office on labour mobility issues) and with firms and industry bodies, to jointly identify, plan and pursue opportunities to strengthen trade and investment through engagements with other markets. There will need to be investment in those parts of government not yet attuned to commercial priorities. The financial and related professional services industry can reinforce the government's efforts by sharing insight into its strengths, capabilities and differentiating features.

  14. UK diplomatic missions are a national asset, and investing to maintain and strengthen them should be a priority. The precise pattern and location of diplomatic missions may change over time (e.g. the next five years could require greater attention to Africa). We therefore recommend that government invest further in its network of Embassies, High Commissions and Multilateral Missions. Consultation with business over such changes is imperative. Where possible, dedicated financial services related staff should be placed in diplomatic missions in priority financial and related professional services markets: it is helpful to have diplomatic staff in post with a deep understanding of financial issues and the importance of data, who can engage with host country financial regulators. Multilateral missions have sometimes been underappreciated, in part because the agenda of multilateral institutions can be slow moving, but they are critical to bringing the UK voice to bear in shaping global standards on economic and financial issues. The opportunity they provide for the UK to build coalitions and alliances, test and lead opinion, and for staff exposure to concomitant skills and experience, must not be underestimated.

  15. Across all of these policies is the need to cater for global developments in tax policies and the international labour market. A country’s tax regime is a key factor in attracting investment, and the size of a country’s international tax treaty network is a key determinant of the overall competitiveness of its tax regime. The UK scores highly in this regard, and so it is vital that the government continues to prioritise international cooperation to ensure the UK can continue to attract inward investment, lead the fight against tax evasion and minimise complexity arising from market fragmentation. For example, the UK should continue to engage with the OECD’s work on addressing the challenges posed by digitalisation as there is a real risk that unilateral actions will result in a patchwork of policy measures, negatively impacting levels of investment and economic growth. In a period of challenging economic conditions across the world, the government should renew its focus on coordination efforts.

  16. Covid-19 has also highlighted the outdated nature of international tax rules on individual residence and place of work. While individuals have been stranded in other jurisdictions due to the virus, the OECD has provided guidance and individual jurisdictions have generally applied some level of easement to prevent individuals who may be working in a state other than their employer’s home territory creating permanent establishment or local payroll issues. However, more businesses may well allow flexible working and more employees may well demand it. This will likely include pressure for more cross-border working, with implications for tax-related issues such as worker tax residency, company residence, and permanent establishment. If these issues can be overcome, the benefits to the UK would be access to a deeper talent pool for UK businesses, including individuals who want to work from another state, with advantages to the UK economy through salaries being paid by overseas firms to UK residents and spent in the UK. Changes in this area would be a complex and challenging. But there is a clear opportunity for the UK to be progressive leader in policies catering for a globally mobile labour market.

[1] Office for National statistics, ‘Gross Domestic Product: Quarter on Quarter growth: CVM SA %’, (12 August 2020), available at: https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/ihyq/pn2

[2] The institutions referred to here are the Bank of England, IMF, NIESR, Office for Budget Responsibility, OECD and World Bank.

[3] Office for National Statistics, ‘Public sector finances, UK: July 2020’, (21 August 2020), available at: https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicsectorfinance/bulletins/publicsectorfinances/july2020

[4] TheCityUK Recapitalisation Group, ‘The demand for recapitalisation: updated estimates of UK unsustainable debt’, September 2020 ,available at: https://www.thecityuk.com/assets/2020/Reports/f973ae0e16/The-demand-for-recapitalisation-Updated-estimates-of-UK-unsustainable-debt.pdf

[5] TheCityUK Recapitalisation Group, ‘Supporting UK economic recovery: recapitalising businesses post Covid-19’, July 2020, available at: https://www.thecityuk.com/assets/2020/Reports/2d5179dbfb/Supporting-UK-economic-recovery-recapitalising-businesses-post-Covid-19-v2.pdf