Britain’s fracking tax incentives: do they pass the test?

It’s funny, if you’ve only ever thought about an issue in terms of other places, when it suddenly it pops up in you back yard. Gives you a different perspective. So the announcement today that the Britain is going to create the “world’s most generous shale tax regime” [£] to encourage ‘fracking’ is a chance to think about all the pontificating I’ve done about tax incentives.

As far as I can tell, we don’t yet know the details of what is being proposed, only the headline. If there’s more today I’ll update this post. But the key message is a slashing of the corporation tax rate from 62% to 30%, and compensation for local communities hosting a well of £100,000 plus 1% of revenues.

Below I have posted two sets of recommendations on tax incentives, one from the OECD, and one from ActionAid’s new campaign. Looking through them, it seems most are unlikely to create any trouble, since these are statutory incentives that will be passed through legislation. But two thoughts emerge initially.

First, will there be a published, transparent analysis of the revenue expected to be foregone, and predicted benefits? This is usually done in the UK through a “tax information and impact note” attached to proposed legislation, but I wonder how detailed it will be, and whether there will be any way to test the assumptions about how much investment the incentives will bring in. Peter Lilley, a conservative MP with an industry background, said yesterday, “I think tax breaks are unnecessary for fracking, based on my knowledge of the oil and gas industry.”

Second, from the “most competitive in the world” headline, it seems these British incentives are not simply designed to tip the investment past the point at which it has a viable net present value, but quite explicitly to entice investment away from other countries. So it’s tax competition. Why isn’t there a statement that incentives should only be designed to make investments viable, as opposed to making already-viable investments more attractive than those in other countries? Is that too vague?

Furthermore, the recommendations generally talk about regional agreements to limit tax competition, but in this case that doesn’t seem relevant: I think it’s less about regional partners/competitors and more about other countries with shale gas potential. Maybe the recommendations should extend beyond regional proximity to cooperation between countries with similar resource endowments

Here are the ActionAid recommendations:

  • Eliminate all tax holidays.
  • Publicly review all tax incentives, assessing tax expenditure (the amount of tax foregone from incentives), ensuring incentives are well targeted and commensurate with the benefits expected to citizens.
  • Ensure that all phases of new incentives require parliamentary approval, and also that any new incentive offered is grounded in legislation which makes it available to all qualifying investors, foreign or domestic. This would effectively mean an end to discretionary tax incentives.
  • Publish a costing and justification for each incentive offered, followed by monitoring of conditions and a tally of costs and benefits, so the public can see the impact of tax incentives.
  • Grant the Finance Ministry (not solely the Investment Promotion Authority) powers over tax incentive decisions.
  • Refrain from entering into stability clauses (which lock in tax incentives long term) when negotiating new tax incentives and investment agreements.
  • Ensure that tax incentives are audited to check that the investment for which an incentive is offered has actually been carried out.
  • Co-ordinate statutory tax incentives with groups of neighbouring countries, in order to counter tax competition.

Here are the OECD principles [pdf]:

  1. Make public a statement of all tax incentives for investment and their objectives within a governing framework.
  2. Provide tax incentives for investment through tax laws only.
  3. Consolidate all tax incentives for investment under the authority of one government body, where possible.
  4. Ensure tax incentives for investment are ratified through the law making body or parliament.
  5. Administer tax incentives for investment in a transparent manner.
  6. Calculate the amount of revenue forgone attributable to tax incentives for investment and publicly release a statement of tax expenditures.
  7. Carry out periodic review of the continuance of existing tax incentives by assessing the extent to which they meet the stated objectives.
  8. Highlight the largest beneficiaries of tax incentives for investment by specific tax provision in a regular statement of tax expenditures, where possible.
  9. Collect data systematically to underpin the statement of tax expenditures for investment and to monitor the overall effects and effectiveness of individual tax incentives.
  10. Enhance regional cooperation to avoid harmful tax competition.
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5 thoughts on “Britain’s fracking tax incentives: do they pass the test?

  1. Martin,

    Interesting post. I have to admit, I am generally a fan of incentives. However, reading this post made me focus a little more on the “most competitive in the world” bit and the idea of using incentives to make the investment viable, as you touch on above.
    It occurs to me in this case that we have a resource in the UK that companies would like to access and sell. We also want them to do that. What we need is to make it commercially viable for those companies to invest in extracting our shale gas. What is not clear is why we need to make it more attractive than extracting another country’s shale gas. If this is a limited global resource, then surely all the extraction companies need is for it to be commercially viable. Whether or not investment in other countries is more attractive, ultimately those companies will want our shale gas.
    The only reason I can see to make investment in UK shale gas more attractive than elsewhere is to ensure we get that investment quickly. What is not clear in this case is that that is the real reason behind this decision.

    David

  2. When you drop the rate of tax on profits, you remove some incentive to incur expenditure. With the rate of tax dropping from 62% to 30%, the after tax cost of allowable expenditure has almost doubled, going from £38 to £70.

    I’m not saying that any of the businesses involved would compromise health and safety or environmental concerns to improve profits as a result, but I don’t like the underlying discouragement to incur costs with regards to fracking.

    My favoured tax incentives, from a policy perspective, tend to be aimed at subsidising the costs incurred, rather than enhancing the profits created. So I’d rather see targeted capital allowances or an enhanced expenditure relief (like in the R&D and creative sector regimes) which encourage, or subsidise, expenditure.

    I figure encouraging expenditure in the UK is better for the economy too.

    • Is that true? If one is looking at ROCE, surely if the tax rate decreases you can spend more and still get the same return so there is less incentive to shave costs?

      I’m no economist, though.

      • I don’t necessarily think others view it the way I do – a lot of people comment that I have a different way of looking at things… I think it might just be a polite way of saying that I have a habit of picking unpopular causes to become passionate about.

        Ultimately, if the businesses that are looking to invest are most effectively motivated by a low rate, that’s all that matters, I guess.

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