BUSINESS BLOG - Ian Welch

Tax policy - has it worsened the downturn?

Tax has – unusually – taken a bit of a back seat recently. In the debates surrounding the credit crunch, issues like regulation, corporate governance and executive pay have taken centre stage.    

But the International Monetary Fund (IMF) put out an interesting paper last month that sought to put tax back on its usual perch. The IMF argued that tax policies had helped to create the credit boom that had preceded the crash. 

How so? Tax regimes encouraged companies to seek finance via debt (against which interest payments could be deducted) than equity (where they couldn't) and made it cheaper for individuals to take on large mortgages. The combination contributed to the unsustainable build-up of credit, the results of which we see in most countries. Not only private equity  companies engineering huge leveraged buy-outs gained – the IMF argues that others too were pushed towards debt financing by the tax rules.   

So what is the solution? The immediate issue could be addessed either by removing the deductibility of interest payments – politically difficult – or creating an ersatz deductibility for the notional costs of equity financing. The latter course of action would also have the  beneficial side-effect of encouraging banks to hold more capital reserves. Probably more likely.

But the real underlying issue is one of tax neutrality. Distortions in the system, whereby one economic activity is effectively favoured over another, inevitably create such problems.  Governments must work towards ironing out these kinks in the system and resist the temptation to 'reward' one group of taxpayers over another.

ACCA has recently issued a policy paper, Tax principles: from Adam Smith to Barack Obama, which spells out 12 basic tenets for a good tax system. Neutrality is crucial. At the last G20 Summit, world leaders made great play of regulators talking to each other cross-borders to learn and share best practice on regulation. They should do the same on tax.

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Financial regulation - what should the future look like?

Financial regulation is now one of the hot topics of the economic downturn. World leaders devoted much of the April G20 summit to it and since then, proposals have sprung forward in the US, Brussels and, today, the UK.      
 
Why the huge interest in a subject traditionally regarded as dry? Partly because of politicians' natural desire to be seen 'doing something' in response to a crisis. Though given the scale of taxpayers' money shovelled into propping up the banks they can hardly be blamed for wanting to reassure their electorates that lessons have been learned - and stronger regulation is a visible way of proving that point.
 
But the key question is - are the right lessons being taken on board?

ACCA has just issued a major report 'The Future of Financial Regulation'  examining the crisis and setting out some principles for sound regulation. We spoke to CFOs, regulators, auditors and other players from the world's major financial centres to ensure we had genuinely international viewpoints.  
 
So what is our conclusion? Most important of all is that governments should remember the lessons of Enron - which landed us with the Sarbanes-Oxley legislation. A rush to introduce heavy-handed 'solutions' tend to produce no solutions at all. Dubai Financial Services Authority came up with an excellent point: "Associating 'light-touch' regulation with principles-based, and intrusive or close monitoring with 'rules-based' is misleading. Those terms are not mutually exclusive'.

Quite so. We must not let the apparent failure of light-touch regulation become synonymous with a victory for rules over principles.

 

The UK government's proposals from yesterday are encouraging to the degree that they are not a knee-jerk over-reaction. The emphasis on reforming governance is spot-on given that failings in that area were central in creating the crisis. The focus on improving consumer and depositor protection is also good as this is key in restoring public confidence in the system.      

 

Not so good is a half-hearted view on the importance of competition - we must disagree with the Chancellor's dismissal of the Glass-Steagall principles of splitting retail and investment banking as 'too simplistic'. Accepting that some institutions are now too big to fail is anathema to good regulation.

But what of our own profession? We have to rise to the occasion and re-examine whether the fundamentals of financial reporting and auditing are still 'fit for purpose'. Better reporting on risk is essential. And are part-time NEDs still a realistic check on executives in huge international banks?

 
So many questions to consider. I urge you read our report and come back to us with your views. ACCA wants this paper to be just part of our contribution to the debate - we want to examine further the key issues raised over the next few months. Your input will be crucial in that process. 

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