Fiscal Strategy

STATES OF JERSEY

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FISCAL STRATEGY

Lodged au Greffe on 8th March 2005 by the Finance and Economics Committee

STATES GREFFE

PROPOSITION

THE STATES are asked to decide whether they are of opinion

to r ef er to their Act dated 29th June 2004 in which they approved the States Strategic Plan 2005 to 2010

and agreed that the States would take steps to maintain a strong and competitive economy and to provide high quality public services, and to their Act dated 7th July 2004 in which they approved the Fiscal Strategy and charged the Finance and Economics Committee to research measures to mitigate the loss of taxation revenues as a result of the agreed changes to the corporate taxation structure, and –

(a ) to agree that a progressive package of tax and benefits, capable of generating additional net annual

tax revenue of £55 million, should be implemented, and that –

(i ) a b ro ad-based Goods and Services Tax (GST) will be introduced in 2008 at a rate of 3%,

fixed for at least 3  years, as set out in the summary of proposals, page  40, of Section  2 o the accompanying Report of the Finance and Economics Committee;

(i i ) t h e p roposals being brought forward for approval by the Employment and Social Security

Committee, in liaison with the Finance and Economics Committee, will include provision to ensure that the effects of GST on those on low incomes will be mitigated through enhancements to benefits implemented prior to, or simultaneously with, the introduction of GST;

( ii i) t a x allowances for taxpayers on higher disposable incomes will be phased out over a

period of 5  years in the manner set out in the summary of proposals, page 43, of Section  2 of the said report;

(b ) to approve the introduction of imputation provisions requiring Jersey residents to pay personal tax

based upon the profits of the Jersey companies in which they have a beneficial interest, (known as look-through' arrangements), by 1st January 2009 as outlined in the summary of proposals, page 47 of Section 2 of the said report;

(c ) to agree that enhanced anti-avoidance measures and new information powers as outlined in the

summary of proposals, page  50, of Section  2 of the said report should be introduced no later than 1st January 2009;

( d ) to charge the Finance and Economics Committee, working with the Environment and Public

Services Committee, to undertake further research, and bring forward for consideration proposals relating to the introduction of environmental taxes, primarily aimed at meeting the environmental objectives of the States Strategic Plan 2005 to 2010, including –

( i) a d d itional taxes on the ownership and use of motor vehicles, on the production and

disposal of waste, and on the consumption of energy;

( ii ) a d evelopment gains tax to be considered in conjunction with the development of a

planning gain policy.

FINANCE AND ECONOMICS COMMITTEE

CONTENTS

Page

Executive Summary 5 Introduction 10

Section 1: The need to reform Jersey's taxation structure 11

W  hy change to 0/10%? 11

O  ptions for filling the £80-£100  million deficit 20

P roblems with Jersey's current tax structure 22

• E x cessive dependence on direct taxation 22
• O v er-reliance on corporate taxes 24
• J e r sey's low taxes 25
• W i dening the tax base 26

T ax options for raising £55  million 29

P rinciples applied in assessing the main tax options 30

C omparison of the main tax-raising options against the criteria 32

• F a irness 32
• E ff iciency, simplicity, flexibility 33
• E c onomy and employment 33
• D i versifying the tax base 35

T he Finance and Economics Committee's overall conclusion 37

Section 2: The Finance and Economics Committee's proposals 38

G  oods and Services Tax (GST) 38

I ncome Support System 41

2 0% means 20% 42

Look-through' arrangements and selective taxes 44

A nti-avoidance measures 50

E nvironmental taxes 51

D evelopment levies 56

Section 3: Alternative tax options 62

P ayroll Tax 62

I ncome Tax changes 65

C apital Gains Tax 68

W  ealth tax 69

T axes and Inflation 71

T he next steps 71

F inancial and manpower implications 72

A ppendix 1:  Examples of the impact on households of 20% means 74 20% proposals

A ppendix 2:  Examples of the impact of the Income Tax Option on 85

typical households

EXECUTIVE SUMMARY

WHY JERSEY NEEDS TO CHANGE ITS TAXES

Jersey is changing the way it raises taxes in order to safeguard the economy. This means that we can maintain our current way of life; our standard of living, our high quality public services, our pleasant environment and full employment for local people.

The States has agreed that in 2008 it will introduce a 0% rate of tax on the profits of most companies, but a 10% rate of tax on the profits of companies in areas such as the financial services sector. These measures safeguard our economy but, as a result, Jersey's tax take is expected to fall by up to £80-£100  million a year by 2010.

Six years of research and analysis by successive Finance and Economics Committees shows that if Jersey does not reform the way it taxes companies, the international financial services industry will, over time, move away from the Island. The result would be a huge fall in Jersey's tax take – in the region of £200-£250  million a year. The stark prospect is that without changing taxes, the Island's economy could enter a downward spiral. Moving to 0/10% is the better option by far.

The move to 0/10% is not designed to feather-bed' the financial services industry, nor is it being soft' on business. The primary motive is to safeguard Jersey's economy, its quality of life and public services, now and for future generations, and to provide continuing and rewarding employment opportunities for Islanders.

There is no magic way of recouping the tax Jersey will lose by moving to 0/10%, but in July 2004 the States agreed (P.106/2004) to implement 4 measures –

• g r o w ing the economy (generates £20  million);

• c u t ti ng waste and increasing efficiency in public services (saves £20  million);

• i n tr o ducing the Income Tax Instalment System (ITIS) (raises £5  million);

• i n c re asing taxes (raises the remaining £55 million).

The Economic Growth Plan proposes a framework in which the economy can produce the target growth of 2% a year.

The Public Sector Change Programme will reduce States spending. It will make the States work better and more efficiently by the introduction of simpler, shared processes. Improving the efficiency of the public sector will save £20  million a year.

The Income Tax Instalment System, a simplified form of Pay-As-You-Earn, was approved by the States in December 2004 and will be introduced in 2006.

However, maintaining Jersey's current levels of public services and benefits can only be achieved by also increasing the tax paid by Jersey residents.

GENERATING £55 MILLION – TWO PRINCIPAL MEASURES

Two main taxation instruments will make good the shortfall caused by moving to 0/10%. Taken together they will raise the revenue required and they will ensure that the tax burden is spread fairly across the community, so that everyone pays a little, but those who are better off pay more.

1. G  o ods andServicesTax(GST)

• A b r oad-based GST of 3% from 2008. The rate would be the lowest in the world and guaranteed to be held for at least 3 years

• O n ly a small number of exclusions: exports and export-related services; transport to and from the Island; construction and letting of residential properties; exported and domestic financial services; life assurance, and postal services.

• A t h reshold of £300,000 for businesses. Those with a turnover of less than £300,000 would not be required to register. Only 1,500 businesses (approximately a quarter) will need to register

• S p e cial treatment for financial services, to ensure that a contribution of between £5 and £10 million per annum would come from this sector.

• A ro u nd £10 million of the total raised by GST would be paid by non-residents of Jersey.

• T h e income support system will protect those on lower incomes.

2. P h a sing outallowances for higher earners (20% means20%)

• T a x allowances for the better-off gradually phased out, affecting only the top 30% of the population with higher disposable incomes.

• E f f e ct on individual higher earners will depend on 2 factors: income and tax allowances. Only the highest earners will lose all entitlement to tax allowances and reliefs.

• N o b ody will pay more than 20% of their income in tax.

• A p h ased approach over 5 years, so the tax bills for even these highest earners will in most cases increase by less than 1% of their income each year. The full effect will not be felt until 2011.

HOW THE COMMITTEE REACHED ITS DECISIONS There are only 3  types of tax capable of raising£55 million p.a. –

• e m  p loyee/employer payroll tax;

• i n c o me tax, either by increasing rates of tax and/or reducing allowances;

• c o n s umption tax such as GST.

Each of these choices would result in Jersey residents paying more tax, but there are important differences in terms of their potential effects on the Island.

Payroll tax

A payroll tax is a tax on wages levied on the employer, the employee, or a combination of both. Taxing the employer increases the cost of doing business, and makes exports (including those of the financial services industry) less competitive. The resulting effect could be fewer jobs in Jersey in the future. Taxing employees reduces take-home pay for workers, just like increasing their income tax. Any payroll tax (on employer or employee) would not be paid by Islanders who do not work (many of whom may be rich).

Raising the rate of income tax

To raise the revenue required from income tax, the following sort of changes would be necessary –

1 . I n c rease the standard rate from 20% to 25% (to generate £20 million); and 2 . R e d uce tax allowances by 25% (to generate £35 million).

This would mean that comparatively less well-off residents would have to start paying income tax for the first time.

Introducing a higher rate of tax for those on higher incomes would not generate sufficient revenue. For example, 30% income tax for incomes over £80,000 would raise £11 million, perhaps less if some of these individuals chose to leave the Island.

Raising the rate of income tax could deter higher earners and wealthy people from settling in Jersey and may encourage others to leave. Island residents would then have to pay even more tax to make up for the lost revenue.

Goods and Services Tax (GST)

A GST on its own might be unacceptable, as it would hit those on low incomes, who could not afford to pay the tax, and would not result in those on higher incomes paying a greater proportion of their incomes in tax. However, a package of GST combined with low income support and the phasing out of allowances for those on higher incomes has the following advantages –

• G  S T widens the Island's tax base so that everyone will contribute, including temporary residents

and visitors. A wider tax base gives Jersey a more secure economic foundation and makes it less vulnerable to volatility in tax revenue. (Almost all successful countries understand this and have introduced some form of consumption tax.)

• J e rs e y residents do not bear the full cost of the tax since over £10 million of the£45 million which GST would raise will be paid for by non-residents.

• A b r oad-based GST is simple to administer and hard to avoid.

• A lt h ough there will be an initial rise in the Retail Price Index, consumption should fall, which in turn should help drive down inflation – making Jersey more competitive and a less expensive place to live.

• E v e r yone in Jersey would contribute a small share, but those on low incomes would be protected by enhancements to the income support scheme.

• P h a s ing out allowances for those with higher disposable incomes means Jersey keeps its headline

rate of income tax of 20%, but the wealthier members of our community actually pay the full 20% rate of tax on their income, ensuring that the tax package remains progressive overall.

Additional research

The States (P.106/2004) required the Committee to examine and report on other types of tax – Environmental taxes

Analysis of the effect of these taxes shows that people change their behaviour to avoid paying the tax. As a result, the revenue raised by environment taxes will decline over time. For this reason, the Committee believes environmental taxes would not be a significant nor reliable source of revenue.

However, the Committee supports the use of environmental taxes to help deliver the environmental objectives of the States Strategic Plan, so is recommending that more research is carried out to identify appropriate environmental taxes which would bring benefit to the Island.

Development gains taxes

By rezoning land for building, the States increases the value of land and the subsequent profit available to its owner. Profits derived from construction projects are already subject to Income Tax, but additional revenue could come from taxing development gains.

Analysis of the effect of this tax shows –

• R e v e nue would not be reliable or easy to forecast.

• A h igh development tax may discourage land-owners from selling land needed for the construction of housing.

• A d e velopment gains tax would not raise significant revenue.

But, to meet environmental policy objectives outlined in the States Strategic Plan the Committee recommends that more research is carried out into a development gains tax.

In making its choice of tax measures the Committee was guided by the following principles –

• F a i rn ess

• E f f ic iency, simplicity, flexibility

• M  a in taining the Island's economic prosperity and employment

• B r o a dening the tax base, stability, minimising avoidance.

The Committee's chosen package of proposals scores well on all these principles.

Most importantly, the package will ensure that Jersey can look forward to a sound economic future which means that the way of life which we all hold dear – with a pleasant environment, a generous level of services and a good quality of life – can be continued for generations of Jersey men and women to come.

REPORT

The Reform of Jersey's Taxation Structure

Introduction

In July 2004 the States agreed to change corporate tax rates in order to maintain a strong and competitive economy. These new rates will be a 0% standard rate of corporate profits taxation, with a 10% rate of corporate profits taxation for companies in the financial services sector. The States agreed that these new rates should be introduced no later than 1st January 2008 (P.106/2004).

The States also charged the Finance and Economics Committee to undertake further research into a Goods and Services Tax (GST), a payroll tax, environmental taxes, development levies and further tax enforcement measures and to bring forward recommendations for the approval of the Assembly.

This Report is the result of that further research. In the first instance it is important to have a proper appreciation of why the Committee is proposing an increase in tax for Island residents. To do this, the background of Jersey's current fiscal and economic situation needs to be understood.

Section 1 of this Report explains the need to reform the Island's tax structure and assesses the main tax raising measures that could be used to meet the revenue deficit arising from the move to a 0/10% corporate tax structure. Section 2 details the research undertaken by the Committee and sets out its tax raising proposals. Section 3 looks at further issues the Committee has considered and explains why it is not proposing alternative measures.

In approving P.106/2004 the States has already agreed the move to a 0/10% corporate tax structure which will result in a budget deficit of between £80-£100 million per annum. The States has agreed that by 2009£20 million of the shortfall should be met by reducing public sector spending, through efficiency savings and cutting waste and that a further £20 million should be generated each year from economic growth. The States has also agreed the principle of raising £10 million by phasing out tax allowances for higher earners. Furthermore, the States agreed that £5 million per annum should be raised from the introduction of an Income Tax Instalment System (ITIS). This leaves a requirement for £45 million per annum to be found from additional tax raising measures.

SECTION 1 – THE NEED TO REFORM JERSEY'S TAXATION STRUCTURE

WHY CHANGE TO 0/10%?

International financial services are by far the most profitable of the Island's industries. They also tend to pay the highest wages.

As a result of the high level of profitability per worker – in the order of £90,000 per worker a year – and high average salaries, the total tax contribution from this industry is considerable. (In the rest of the economy the average profitability per worker is very much lower – roughly £6,000 a year). It is mainly because of the very high profits in this sector of the economy that the States are able to deliver a level of public services broadly similar to that of the U.K. yet with very much lower tax rates – in particular lower personal tax rates.

It would be difficult to imagine an industry, other than financial services, which was better suited to a small Island economy such as Jersey. It is one of the most profitable industries in the world and it uses relatively little land. Any alternative international industry that might be tempted to locate in Jersey would be very unlikely to be able to contribute so much to the economy and tax revenues. Therefore, losing the international financial services sector would reduce average wages and significantly reduce the average profitability per worker on the Island. To continue to deliver the same standard of public services the average person earning significantly less would have to pay a much higher proportion of their income in tax.

There are 2 key elements which influence the competitiveness of Jersey's financial services industry in the current international environment in which the industry must work. These elements have arisen independently of each other  but do  interact in terms of  the solution to be proposed to the  different  challenges  they  pose.  These 2  elements are –

• t a x c ompetition generally by rival jurisdictions competing for the establishment and/or retention of large financial services providers such as banks and fund managers; and

• c h a n ging European Union (E.U.) rules on harmful tax practices, applicable to corporate taxes only, which affect the corporate vehicles used by customers of financial services providers.

General tax competition

To meet recent and growing international competition, the States agreed in July 2004 that the rate of corporate profits tax applied to the providers of international financial services needs to be at, or close to, a maximum of 10%. This would bring it in line with what Jersey's competitors are doing (Singapore, Guernsey and the Isle of Man are moving to a rate of 10% and Dublin already has a rate of 12.5%). Above this level Jersey would rapidly become uncompetitive as a place to locate providers of international financial services. It should be stressed that this situation would have arisen irrespective of the E.U. tax rules which also lie at the heart of the fiscal strategy. In that respect, Jersey would in any event have been facing significant pressure on its revenues derived from the corporate taxes of large Jersey-based financial institutions because of the need to stay aligned with rates being offered by major competitors. The competition element is calculated to account for up to £50 million of the potential £80-£100 million shortfall identified as the consequence of a move to the new fiscal structure.

E.U. rules on harmful tax practices

In addition to a competitive rate of corporate profits tax, the providers of international financial services also require the legal mechanisms to be able to deliver the type of financial services their customers require. One very important service is the provision of a corporate legal entity, resident in Jersey, that does not have its profits taxed. Such legal vehicles are commonplace internationally and are currently available in Jersey through the Exempt Company structure. However, these exempt company structures are not available to Jersey residents. International pressure, particularly from the E.U. and the United Kingdom (U.K.) resulting from the initiative on harmful business taxation (known as the Code of Conduct on Business Taxation), means that Jersey can no longer maintain this discrimination. Failure to address this issue could well result in action by the U.K. or the E.U. which would very seriously undermine the ability of international financial institutions to continue to operate from Jersey. The consequences for the Jersey economy would be serious.

In order to ensure that the providers of financial services can provide the products they need for their international customers, the facilities of the existing Exempt Company structure will need to be made available to residents as well as non-residents of the Island. This will be achieved by introducing a general rate of corporate profits tax in Jersey of 0%. This removes the discrimination between companies with resident and non-resident shareholders, and hence removes the threat of unilateral action by the U.K. and E.U.

However, in July 2004 the States agreed that in order to safeguard as much as possible of the tax revenue generated from corporate profits tax, those entities regulated by the Jersey Financial Services Commission would be excluded from the 0% rate and a higher rate of 10% applied to them.

It is a feature of the way the E.U. interprets its approach on harmful tax practices that assessing one sector at a higher rate of corporate tax (10%) than is the general rate in the economy (0%) is acceptable. It is nevertheless important to consider 2 further points in this respect, one of which legitimises the higher rate, and the other which limits the wider application of a 10% rate in the Jersey economy –

• I t i s considered acceptable to have a higher rate in the economy than is the norm on the basis that the sector chosen is effectively being discriminated against' compared to the general rate of corporation tax

applied

• I n o rder to justify that the general rate is indeed 0%, it may be unwise to seek to add any additional

sectors to that defined for financial services and subject to the higher 10% rate. This would call into question the viability of the general 0% structure which, as can be seen, is vital for the separate purpose of maintaining the benefits of Exempt Companies by another method. However, it has been clear from negotiations with both HM Treasury and, through them, with the E.U. Code of Conduct Group on Business Taxation, that the possibility of adding local utility suppliers to the 10% higher rate band should not jeopardise the position pertaining to the general rate (see below).

The States have therefore concluded that in order to keep the financial services sector competitive, the zero profits tax legal entity must, in general, be made available to all companies, irrespective of the place of residency of the beneficial owners. This involves setting the general rate of corporate tax at 0%.

These 2 measures will, inevitably, lead to a substantial loss of tax revenue from the current economy. However, the alternative of leaving the current tax structure unchanged would result in a considerably worse outcome. The financial services sector of the economy would become uncompetitive in its international markets, and companies would move to more competitive jurisdictions. This process of moving both jobs and business to more competitive jurisdictions is not just a theoretical threat, but can already be seen to be happening worldwide as mobile business, such as financial services, seeks to maximise its advantages in terms of differential costs, of which labour costs and total tax burden are two key determinants in location decisions.

Some attention has been given to the durability of a 0/10% corporation tax structure in a fast-changing world. The E.U. agreement specific to the Committee's proposals is contained in the record of the meeting of the combined E.U. Finance Ministers, known as ECOFIN, on 3rd June 2003. These ECOFIN Council Conclusions recognise the acceptability and timescale for implementation of the 0/10% proposals to the European Union, which throughout the negotiation process had also gained the full support of the United Kingdom government.

It must be acknowledged that future developments within the E.U. or in other international bodies, or even matters involving individual countries, could evolve over time to bring the 0/10% structure back for further debate. However, Jersey has received specific assurances from the U.K. Government that the issue at the heart of these reforms is one of perceived harmful tax practices, i.e. discrimination in tax treatment between different types of company and differing residence of shareholder, and that in the move to a 0/10% corporate tax structure Jersey has addressed these issues. In addition, Jersey has been assured by the U.K., the E.U. and the OECD in different discussions that the various international initiatives on taxation with which the Island is involved do not have the harmonisation of tax rates as their objective. Secondly, the U.K. Government, together with other like- minded nations such as the United States, Australia, Canada, Ireland and some others, are clearly working to an agenda which recognises and espouses tax competition internationally as the acceptable norm. Given that the 0/10% structure is inherently about tax competition then alignment with those countries on the acceptability of the tax competition approach should provide some comfort as to the potential durability of the proposed 0/10% solution.

Some attention has been given to the prospects for defying the E.U. rules – since Jersey is not within the E.U.'s fiscal territory – and therefore avoiding the need for the general 0% corporate tax rate. The Committee strongly believes that this would be contrary to the interests of the Island and regard the following as the principal reasons for this stance –

• T h e E.U. element of the proposed changes only accounts for some £30 million of the identified£80-

£100  million shortfall identified as the monetary consequence of the proposed change in the Island's fiscal system. The remaining part is derived from downward pressure on corporate taxes generally from increasing international competition. A policy of refusal to consider aligning ourselves with E.U. rules which, even on the best possible outcome, might result in addressing less than 50% of the Island's actual problem would not seem to represent an acceptable balance between risk and reward.

• J e rs e y is positioned on the periphery of the European Union and conducts much trade with it and derives

significant opportunities from such positioning to develop financial services and other business with E.U. nationals. A policy which contemplates not just isolationism in this respect, but also one which would have the effect of undermining the E.U. Code of Conduct exercise, with attendant damage to the U.K. relationship with its E.U. partners, would seem again to represent a very high-risk approach.

• T h e United Kingdom is determined to ensure compliance by its Dependent Territories with the E.U. Code

of Conduct with similar pressures faced both by Guernsey and Isle of Man in this respect. Although there are constitutional arguments to invoke to resist this, Jersey has already seen the U.K. prepared to contemplate a highly pressurised approach to forcing this compliance with threats of unilateral action by them against the Island to achieve such an outcome should the Island ignore the Code of Conduct requests. One such measure would be the revocation of the exemptions permitted to Island-based businesses within the U.K.'s Controlled Foreign Companies legislation. Such revocation would have a rapid and detrimental tax impact on all U.K.-owned businesses in the Island and probably force them to re-evaluate their options for representation on the Island over time. Where this would create most immediate concern would be in the banking sector with a handful of large U.K.-owned banks accounting for a very high share of the Island's direct tax revenues and nearly 50% of the Island's financial services workforce. There are other areas where the U.K. could take unilateral economic actions with severe consequences for Jersey, such as in withdrawing existing double tax exemptions, and the possible implementation of withholding taxes on inter-bank deposits by Jersey-based institutions into the U.K. All such measures are potentially serious for any large U.K.-owned business, particularly in financial services, in the Island. Therefore, they do not in the eyes of the Committee represent an acceptable balance of risk if these policies were to invite their implementation or even threat, recognising that business cannot function well in the face of uncertainty and that threat alone may be sufficient to create such uncertainty and attendant adverse economic decision making.

The taxation of Jersey utilities at 10%

As stated above, within the EU Code of Conduct on Business Taxation process there is an option open to the Island to include utility providers, both public and private sector, within the 10% higher rate band which has primarily been designated for financial services companies. This results from a particular feature within the policy approach of the EU Code Group in its determination of what constitutes harmful business tax practices' in that local utility providers are not deemed to be influenced by international competitiveness on tax rates in terms of their location decisions. They are generally not mobile businesses and their market is essentially confined to the local population where the utility is located. Thus, the EU approach is that it is indifferent as to whether such utilities are taxed within either the general rate arrangements for corporate tax or at the higher special' rate.

Jersey can therefore take either of these options.

Although the amount of corporate profits tax which will arise from taxing Jersey utilities at the 10% rate is currently rather modest at around a maximum in aggregate of £1  million per annum, and arguably represents no more than a transfer of receipts where such utilities are in any event owned by the States, it is considered useful to take the option of taxing utilities at the higher rate for future policy flexibility. It is possible that in future, particularly where any privatised utility may be concerned, that the profit levels and taxes involved may be significantly higher than they are today and the option of being able to tax these at the special rate would therefore be of some value. This is all the more so given that the option incurs no current political nor economic cost for the Island.

The precise definition of utilities to be effected has yet to be finalised but for indicative purposes is expected to include Jersey Post, Jersey Gas, Jersey Electricity, Jersey Telecom, and Jersey Water.

Consequences of delaying decisions

A final, but vital, component of the need for change is the requirement to act quickly and decisively. Whilst the Island was successful in winning a longer period to enact tax reform than had originally been likely, there is no doubt that competition for financial services business worldwide is accelerating, based in no small part on the attraction of low rates for providers in key competitor jurisdictions and the absolute minimum requirement of being able to continue to provide tax neutral vehicles to global investors by finding a solution to replace the Exempt Company structures on which so much of the business flow of Jersey's financial services industry depends.

Business in the Island will not welcome any drawn-out period of uncertainty regarding the Island's recognition of these challenges and the willingness to address them quickly. Customer business can be lost unless certainty of applicable tax treatment can be given on any given structure for the whole of its intended life span – sometimes up to 20  years. Separately, large multi-national financial services providers, who are represented in Jersey and in many of the Island's competitor jurisdictions at the same time, have many options for switching business, capital and jobs at a rapid rate away from the Jersey to such competitor jurisdictions with relative ease. It should also be borne in mind that once such economic activity is lost by Jersey to competitor places then it is unlikely to return in the future without a very compelling reason to do so.

Mitigating the loss of corporate tax revenues

The estimated loss of some £80 – £100 million in tax revenues arising from the move to 0/10% is likely to be a worst case scenario which can be broadly categorised as follows –

International Business Companies – up to 10%. Many of the international business companies who pay substantial tax revenues are already close to an effective rate of tax of 10%, so the majority of that business should stay once the proposed 10% rate is introduced, but a few may well go.

Exempt Companies – up to 10%. This relates to the loss of the exempt company fee of some £10 million as they will all be categorised as zero rate. However, it should be possible, subject to international competitive pressures, to recoup this loss through, for example, increasing the annual filing fee.

Non-finance business. In broad terms, some 40% of the potential loss relates to non-finance business. Some 20%

to 25% relates to non-finance business trading locally whose shareholder base is outside the Island.[1] There is a similar amount of non-finance business trading locally which is also owned locally. Although these businesses

will no longer pay corporate tax on their profits, the majority of any loss of tax revenues will be made up by increasing the personal tax liability of Jersey resident shareholders (see the comments on look-through' arrangements in Section 2).

Finance industry companies. The majority of the loss, perhaps up to 60%, is estimated to come from income tax levied on companies involved in the finance industry currently paying at an effective rate of tax close to the

standard rate of 20% which will fall to be taxed at 10% under the proposals.

The above represents an analysis of a constantly changing picture, and although carried out many months ago on the basis of the tax information available at that time, the Committee is confident that it does remain a realistic estimate of the size and nature of the potential problem.

The potential impact of not adopting 0/10%: Jersey without an international financial services industry

In considering its options, the Committee has looked at how the Island's economy might look in the absence of the international financial services industry at its present level. This might be the outcome if the States failed to introduce measures to reform the corporate structure in response to the changes which are taking place in competitor jurisdictions. It looked particularly closely at that part of the financial services industry that provides services to the international markets including those serving non-resident clients. This industry is highly mobile and it would probably be that the most profitable parts that would leave first if the Island's corporate tax structure became uncompetitive. There could be a substantial change in the structure of the financial services industry in the Island within a relatively short period.

There would be a major shock to the Island's economy during the first few years after companies had gone, though they would be unlikely to leave the Island at the same time. The loss of some companies could have a bigger effect on the overall economy than others. The following effects would be likely to be felt in the Island during the first few years after the shock of the emigration of these key companies –

• e m  p loyment in financial services would fall from today's level of 12,000 jobs to 1200-1500 jobs;

• a la r ge fall in demand for goods and services (for example in the shops) since employees in the financial services industry have the highest disposable incomes and spending power;

• e m  p loyment outside the financial services sector would also fall. Significant unemployment outside the financial services sector would be likely;

• p ro p erty prices would fall and the age structure would alter as younger people would be likely to dominate those leaving the Island in search of employment;

• t o ta l population would fall, and the fall could be considerable – possibly by 20-22,000 (with the working population falling by 14-16,000);

• u n d e r the current tax structure, States' revenue could decline by £250-£300  million per annum compared to the present total of £450  million;

• i f c u rrent levels of services were maintained, States' spending could fall by much less (perhaps only by £100  million or less) because it would tend to be older residents who would remain in the Island. The immediate liability for States' pensions would hardly fall at all;

• t h e p otential deficit in the States Budget could amount to £200  million in each and every year;

• t h e p otential tax base on which to make up this shortfall would be much smaller than it is now;

• t o m  eet any shortfall by tax increases or service level reductions would require much higher tax rates, or deeper cuts, than meeting a similar shortfall from the current tax base.

The Island would probably begin to recover after this initial shock, but the economy would look very different from the way it does now. Exactly how the economy would look would depend on what, if anything, replaced financial services. In the absence of a replacement the following chain of events would be likely to unfold after the first few years following the shock –

• w  ag e s in the Island would fall as firms would be able to offer lower wages with the rise in unemployment and in response to the decline in overall profitability;

• t o m aintain anything like the current population, an alternative export industry would be required. This industry would need to be one where any additional costs arising from Jersey's physical location were at least off-set by some cost or quality advantage of operating from the Island;

• a s s u ming such an industry could be found, output in the Island would start to recover, though almost certainly with much lower levels of profits and wages compared to now;

• p o p u lation would stabilise, and might even start to grow again, though the new people coming into the Island would have a different set of skills;

• h o u s e prices would stabilise, but very likely at levels considerably lower than now. It is likely that many younger people would find that their mortgage debts were larger than the (now lower) value of their

properties.

If the population had fallen significantly (which is likely), it might take a considerable time for property prices to recover. The problem of "negative equity" in property could last for a considerable time. The reduction in both property prices and wages would make tourism and, possibly, agriculture more competitive. In the absence of a significant new industry they would probably become the dominant industries again in Jersey and the main sources of employment for Jersey people.

Unless any new industry was capable of generating similar tax revenues for the States and wages for residents it would not be possible to maintain the current position of low tax rates with similar public spending per head as the U.K. Either tax rates would need to increase very significantly (i.e. up to the equivalent of U.K. rates) or public services would need to be cut drastically. If the former was adopted, high-income residents, particularly those with significant investment income, would be discouraged from remaining in Jersey because of the higher tax rates. To the extent that such residents left the Island this would lead to further downward pressure on tax revenues.

Exactly where the economy would end up is impossible to predict with any accuracy as there are too many unknowns. However, the typical pattern for small Island economies is that they tend to have lower average standards of living than their adjacent mainland'. Among other things, this reflects the additional transport costs of getting to and from the Island. The exceptions are where the Island has some clear and significant underlying economic advantage over the mainland. In the case of Jersey there is currently little evidence that the advantages of the Island for agriculture or tourism are that significant. The economic value of the Island's characteristics for these two industries may, therefore, be limited. As a result, levels of Gross National Income per head might fall from the 2003 level of £34,000 to around or below the average U.K. level – £18,000, once the economic adjustments had worked through the Island.

The delivery of the current level of public services combined with the current tax structure could result in a deficit in the States Budget of around £200 million every year. This is not sustainable, even in the short term, so some very large adjustments in either taxation or spending would be needed.

Conclusion

A flight of international financial services from Jersey would lead to an economy that  could  not  sustain  the  current  level  of  public  services  on  the  present  tax structure.

The loss of tax revenue caused from international financial services leaving the Island would be far higher than the shortfall produced by altering the tax structure to a 0/10% corporate tax regime.

In addition, the total economic activity on the Island would be likely to be lower, but with a less than proportionate decrease in the demand for public expenditure (including States' pensions). Tax rates for future residents would therefore be likely to  be  significantly higher  in  the  absence  of  the  international  financial  services business.

OPTIONS FOR FILLING THE £80-£100 MILLION DEFICIT

The move to 0/10%, though essential to maintain the Island's prosperity, will create an £80-£100 million deficit in the States finances. There are essentially only 3 available options to meet this shortfall. These are –

• r e d ucing States spending by improving the efficiency of the public sector and/or cutting public services;
• g en  e rating additional tax revenue through economic growth;
• ad  d  i tional taxation.

A clear message from the fiscal strategy consultation and also from the Imagine Jersey process is that whilst the public want the States to improve efficiency of the public sector there is little desire to save money through significant reductions in the range and quality of services provided. In particular, there appears to be little appetite to cut provision of core services such as education, health, social benefits and law and order which account for well over three-quarters of States spending.

Furthermore, as most of the services provided by the States have a positive redistributive impact – that is, tax revenue taken from the better-off is used to provide services for the not-so well-off – the effect of cutting services would, in general, harm the less well-off more than it would the better-off.

The Finance and Economics Committee has proposed, and it has been agreed by the States, that the annual increase in total States' net expenditure should be limited to one per cent less than the underlying increase in the Retail Price s Index (RPI(X)) for each of the years 2005 to 2009. This should ultimately cut States spending by up to £20 million each year. The Committee believes that these cutbacks in States spending are achievable and realistic targets. However, the Committee does not believe that further significant savings are possible without drastic cuts in the provision of public services such as education, health and social benefits.