Tax

Not now, Darling

Britain has botched the taxation of its rich foreigners

IT TAKES special ineptitude to cheapen a principle without getting anything much in return. But this week, in a do-nothing budget devoted to plastic bags and cavity-wall insulation (see article), Alistair Darling, Britain's hapless chancellor of the exchequer, showed he is equal to the task. Mr Darling confirmed his plan to change the taxation of rich foreigners living in Britain so as to make it fair. Equity—particularly the idea that people with similar incomes should pay similar tax—is a good basis for taxation, yet the government's reform is such a catalogue of blunders, muddled thinking and unknowable consequences that it ought not to have been proposed at all.

Britain has roughly 114,000 people claiming non-domiciled status. Until recently Britons probably thought “non-dom” belonged to the bizarre shorthand of lonely-hearts columns. But City financiers grew wealthier and voters think they have rumbled an injustice: Britain welcomes very rich people who get away without paying their share of tax.

Non-doms pay tax on the income they earn in Britain and the income they bring into the country, but not on the income they leave abroad. That raises about £4 billion ($8 billion) a year in income taxes. Britons, by contrast, are taxed on their worldwide income. Many countries tax foreigners posted abroad for a few years differently from the natives. But Britain's rules are generous and flawed. Non-doms and full taxpayers can be hard to tell apart. Astonishingly, because domicile can be “inherited”, you may be non-dom even if you were born in Britain and have lived there your entire life. And the spirit of the rules is easily broken, by casting taxable foreign income and capital gains as untaxable foreign capital.

These flaws breach one of the three principles of sound taxation. As well as being simple and seeking not to distort the economy, taxation should be fair. A system that taxes similar people in similar situations different amounts distorts behaviour, offends against a sense of justice and thus undermines compliance. Britain's system fails the test.

But so does the government's remedy. Under the new system, non-doms will face a £30,000 annual fee after seven years if they want to keep their status. Many will still pay wildly different amounts from the family in the mansion next door. Nor will the exchequer benefit much. Even under the Treasury's assumptions, the reform will raise only £600m a year—loose change amid tax revenues of £600 billion.

The goose hisses

Even that may overstate its earning power. The government rushed out its reform to trump a lousy Tory plan and then chopped and changed it. That has led some non-doms to conclude that Britain is no longer safe. The City is echoing with bankers prophesying an exodus: of shipping tycoons to Athens and private-equity partners to Geneva. It is impossible to know how many would really forsake London's schools, arts, restaurants, shops and—most of all—its financial expertise. If the City really depends on the slender non-dom status to survive, its days are probably numbered in any case. Yet some will leave. Liquidity is usually hard to shift, but 1960s New York taxed the bond market to London.

What to do? A wholesale reform of Britain's tax code would set up something fairer. Non-doms who settle in Britain need at some point to be treated like everyone else. Loopholes should be closed. But that is true for the whole of the tax system—indeed the treatment of non-doms may be less inequitable than, say, the varying treatment of depreciation or of married and unmarried couples. Reform by all means, but reform methodically and with a sense of what you will gain by it.