If Brexit Negotiations Go Badly, the U.K. Has a Fallback—becoming the Next Switzerland

Brexit Tax
Attendees stand in front of a backdrop of the City of London at a "Paris Meets London" meeting organized by Paris Europlace, the French capital's lobby group, at the Shangri-La hotel in The Shard in London, on February 6. Paris could lure as many as 20,000 workers from Britain's finance industry with the exodus potentially starting within weeks as the U.K. begins its withdrawal from the European Union, according to Europlace. Jason Alden/Bloomberg/Getty

If Britain's exit from the EU goes horribly wrong, the U.K. government has hinted at a contingency plan: radically reduce corporate tax rates, turning Britain into an irresistible tax haven for international companies. In an interview in January with the German newspaper Welt am Sonntag, Britain's finance minister, Philip Hammond, suggested that if the EU were to impose damaging trade barriers, the U.K. would have to slash its corporate tax rate to protect the economy. "The British people are not going to lie down and say, 'Too bad, we've been wounded,'" he said.

The idea that one of Europe's largest economies could turn itself into a tax haven has sparked outrage from senior EU figures, who complain that Britain is already a de facto tax haven. Since 2007, Britain has reduced its corporate tax rate from 30 percent to 20 percent—the lowest of the G-7 group of major economies—and it will fall to 17 percent by 2020, the lowest in the G-20.

The aim has been to boost foreign direct investment and jobs by making the U.K. a more desirable—read: cheaper—place for multinationals to set up subsidiaries. It has perhaps come at the expense of France and Germany, which have much higher rates.

Any further cuts and Britain would start to look "seriously competitive," says Richard Teather, a senior lecturer in taxation at Bournemouth University in England and a proponent of tax reductions. "New trade barriers might balance this out with the EU, but in global terms we would have a key advantage."

But there are big risks to Hammond's potential plan. Rivals could cut their own tax rates or put up new trade barriers. (U.S. President Donald Trump has pledged to lower the corporate tax rate in America from 39 percent to 15 percent.) And the EU could finally push through its Common Consolidated Corporate Tax Base, a policy that would force local companies to report taxable income on a country-by-country basis. "This would seriously hinder Britain's attempts to attract European businesses by removing their ability to shift profits elsewhere," says Alex Cobham, director of the Tax Justice Network.

Perhaps Hammond's bigger challenge, though, would be selling his plan back home. In the wake of the EU referendum and in response to simmering discontent with disparities in wealth in the U.K., Prime Minister Theresa May promised to create a Britain "that works for everyone."

But many economists argue that cutting corporate taxes would do just the opposite, further enriching big businesses while eroding public finances at a time when living standards are expected to fall. "Brexit already implies a significant loss of [gross domestic product] for the U.K.," says professor Anand Menon, director of U.K. in a Changing Europe, a think tank based at King's College London that produces independent academic research on U.K.-EU relations. "So there's a big question as to whether we could actually afford these cuts."

Some policy experts have suggested Hammond would be unlikely to carry out this threat and is really just seeking leverage ahead of negotiations with the EU. "With public finances in all European countries likely to come under pressure from economic disruption caused by a 'hard Brexit' and intensifying demographic pressures on health and pension spending, a race to the bottom in corporation taxes is the last thing that either side will need," says Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics, an economic analysis consultancy for financial professionals.