This post is the updated version of a contribution published on the Oxford Business Law Blog on 7 July 2016.

Immediately after the EU referendum, a French commentator predicted that, after Brexit, the United Kingdom UK would likely become a regulatory and/or tax haven by lowering corporate taxes and deregulating its economy to attract relocations from the Continent and elsewhere. Even out of the EU, the UK would still have the advantages of proximity to the largest economic free trade area on the planet and perhaps, depending on the outcome of the negotiations, of still being associated with it one way or the other. A few days later, George Osborne, then still fully in charge as Chancellor of Exchequer, appeared to have plans consisent with that prediction, as he announced his intention to lower the corporate income tax rate to 15%, which would be the lowest among large economies.

Following his replacement with Philip Hammond a few days later in Theresa May’s cabinet, that plan was apparently abandoned. But some six month later, in her Lancaster House speech, Theresa May explicitly used the tax/regulatory haven option as a counter-threat to those ‘voices calling for a punitive deal that punishes Britain and discourages other countries from taking the same path’. In her own words, ‘Britain would not – indeed [they] could not – accept such an approach,’ famously adding that ‘no deal for Britain is better than a bad deal for Britain’, and then stating: ‘Because we would still be able to trade with Europe. We would be free to strike trade deals across the world. And we would have the freedom to set the competitive tax rates and embrace the policies that would attract the world’s best companies and biggest investors to Britain. And – if we were excluded from accessing the Single Market – we would be free to change the basis of Britain’s economic model’.[1]

The Financial Times was quick to dismiss Theresa May’s ‘Plan B’ (turning the UK into a ‘Singapore of the west’) as an ‘empty’ threat that would never be executed upon, given its inconsistency with May’s far from neo-liberal political philosophy. As I write, the political days of Theresa May as UK Prime Minister appear to be numbered, so one may wonder: would that Plan B become more credible under a new Prime Minister with less of a distaste for pro-business policies, such as, for instance, Boris Johnson? The simple answer is ‘no’, and not because a Boris Johnson Cabinet would necessarily be unlikely to execute on it, but because, even if it did, Plan B would be unlikely to harm the EU and its Member States.

In the present political environment, the UK is in fact highly unlikely to attract any significant number of foreign businesses.[2] Relocating is costly. If a UK location is no longer cost-effective down the road, for instance because the relevant policies are changed, a second relocation will be needed, adding to the cost of the prior one. Hence, businesses will bear the costs of moving to the UK only if they can be persuaded that the new attractive tax and legal environment is there to stay. The problem is that the UK is not currently in a position to credibly commit to such a stable business-friendly environment.

Jurisdictions attracting foreign business with favourable tax or legal treatment (think of Luxembourg or Delaware) tend to have relatively small economies, where the revenues for the State from the economic activity generated by the favourable tax or regulatory regimes are a significant portion of the total. That makes the State’s commitment credible, because the harm to public finances from reneging on the promise to maintain the favourable status quo would be huge and, as a consequence, the political system can be expected not to meddle with the existing arrangements.[3]

A large economy like the UK’s is thus at a disadvantage from this point of view. Yet, countervailing factors may still allow a large country to attract a disproportionate amount of economic or financial activity within its borders. After all, the City of London has attracted financial activities from all over the world for decades despite the large size of the UK’s economy. That is not to say that the UK won the competition in financial services via regulatory or tax dumping. It means, rather, that the UK was eventually able to credibly commit to preserving the quality of its regulatory and tax environment over the long run.

How did it do it? There are, of course, many explanations. But arguably, in the past decades, the appeal of the City as a financial centre owed much to the high quality, stability, and trustworthiness of UK institutions. A long tradition of parliamentary democracy, the rule of law, independent courts, stable governments, free and inquisitive media, a strong legal profession and, relatively speaking, a predictable, largely moderate electorate that could be expected not to be willing to renounce the advantages of hosting a highly profitable financial centre all played an essential part in the City’s success.

The context is now different. First came the diffused, and (arguably) justified, anger against bankers following the financial crisis. While UK policymakers were arguably no harsher than others in reshaping financial regulation, there can be no presumption that a pro-business and/or pro-financial institutions agenda would not be severely punished at the next general election. Then, and relatedly, the EU referendum has given a severe blow to the UK’s political institutions’ credibility. To an external observer, the very decision to ask such a complicated (and open-ended) question to the electorate via a simple majority vote looks reckless. The quality of the EU Referendum campaign debate and coverage was surprisingly dismal, while the low instincts and fleeting emotions of the enraged majority in favour of Leave entail a degree of unpredictability in British politics that was hitherto unacknow­ledged.[4] Furthermore, the cluelessness of politicians about what to do after the unexpected outcome, and, more generally, the messy state of post-referendum national politics, added a final touch of amateurism to an already grim picture. But when things appeared to be back on track under the proclaimed strong and stable leadership of Theresa May, there came, first, the puzzling refusal to obtain the Parliament’s approval before triggering Article 50, which added a touch of surrealism to the framework of a constitutional order in which the only certainty is its Parliament’s sovereignty, and required the pronouncement of the UK Supreme Court.[5] And then, just after Parliament had authorized Brexit in 130 words, a snap election called to strengthen the UK Government’s position in the Brexit negotiations produced a hung Parliament and the surge in popularity of an old-style Marxist.

In short, the post-EU referendum uncertainty relates not only to the future of UK/EU relationships, but also to the stability and trustworthiness of British political institutions. That uncertainty may not be enough to erode the competitive advantages for firms that are already established in the UK (for them, relocating elsewhere will be a certain cost to be compared to the uncertain ones of remaining where they are), but makes any attempt to attract new businesses or to rebrand the UK as a tax or regulatory haven at the border of the EU extremely unlikely to succeed.

To conclude, EU negotiators should be unimpressed if ever their UK counterparts threaten to turn the UK into a tax and/or regulatory haven: even if the UK really went down that road, in the post-EU referendum political environment it would attract very little business. 

Luca Enriques is the Allen & Overy Professor of Corporate Law at the University of Oxford, Faculty of Law.

This post is part of the ‘Brexit Negotiations Series’.

 

[1] Emphasis added. There is no trace of such a threat in the White Paper on Brexit. See Department for Exiting the European Union, ‘The United Kingdom’s exit from and new partnership with the European Union’ (2017).

[2] Depending on the magnitude of the dumping, however, it may succeed in retaining existing UK-based businesses, which is not, of course, what the threat is about.

[3] See, eg, Roberta Romano, ‘Law As a Product: Some Pieces of the Incorporation Puzzle’ (1985) 1 J Law Econ Organ 231-35.

[4] It is of no relief that voters are not acting more rationally elsewhere. Even leaving aside the recent important exceptions of core EU countries such as France and the Netherlands, the point here is whether one could trust voters to act more rationally in the UK than elsewhere.

[5] R (Miller) v Secretary of State for Exiting the European Union [2017] UKSC 5.