A Requiem for the Non Dom Rules
How a 200 year old tax break shaped modern Britain and why its demise should hasten the quest for a new national economic model
Suffice it to say that nothing that Jeremy Hunt said in his reckless and cynical budget last week required me to revisit my verdict on the Tory’s 14 years of economic misrule. His claim to be cutting taxes when he is actually raising them, his cutting of defence spending at a time of rising security risks, and the brazen dishonesty of fiscal forecasts based on implausible rises in fuel duty and four years of eye-watering austerity for already broken public services demeans him and his office. As for his “ambition” to abolish national insurance at a cost of £40 billion, predictably applauded by the increasingly ridiculous right-wing press, enough already.
But there was one item in the budget that is worth dwelling on. Hunt’s decision to scrap the non-dom rules has largely been seen through the prism of Westminster politics. It was certainly hypocritical of the Tories to steal a flagship Labour policy that they had long claimed would raise little money and would in fact be economically damaging. It is also true that it sets a trap for Labour which had earmarked the roughly £2.7 billion that Hunt now expects it raise for its own priorities. But what is missing from the debate has been any acknowledgement of the extent to which the non-dom regime made modern Britain and underpinned its economic model.
Colonial Relic
In fact the non dom regimes has been shaping Britain’s economic model for more than 200 years. Its origins can be traced to 1799 when Pitt the Younger introduced the first income tax introduced to finance the Napoleonic wars. Under pressure from the colonial plantation owners, the government agreed to limit this tax to income earned in Britain. Income from overseas would only be taxed when it was “remitted” to Britain. Thus was the wealth and power of Britain’s domestic oligarchy entrenched.
That wealth and political power helped Britain’s colonialists see off the first serious attempt to end the tax break. In 1914, the Lloyd George government sought to limit the "remittance basis” for taxation only to foreigners. Parliament instead invented the notion of domicile, distinct from nationality or residency, which hinged on largely self-defined notions of where you consider be your permanent home. You could be born in Britain, live in Britain, but if your heart was someone else, then you wouldn’t have to pay UK tax on your worldwide income. Non-dom status could even be inherited, along with your fortune. This arcane system has persisted for the last 100 or so years.
But if the non-dom regime had its origins in the first great era of globalisation, it really came into its own in the second. There are many reason why the City of London roared back to life as a global financial centre at the end of the 20th century after decades in the doldrums. Some focus on British exceptionalism: the common law, the English language, a convenient time zone and strong institutions. Others credit the creation of the Eurobond market in the 1960s, or the Thatcher government’s decision to abolish capital controls and sweep away a raft of other regulations in what was known as Big Bang. Crucial too was British membership of the European Union, which created a single European market for financial services.
Globalisation 2.0
But underpinning all of this was a uniquely favourable British tax system. This helped secure London’s preeminence in two ways. Firstly, it made London a magnet for the world’s newly-minted super-rich who were able to enjoy fortunes in places like Russia and central Asia following the fall of the Iron Curtain from the security of new homes in London without being troubled by the UK taxman beyond what they bought onshore. Indeed, thanks to other ancient arrangements invented to preserve the wealth of Britain’s own wealthy families, such as trusts, partnerships and anonymous companies, they could even shield the wealth they bought onshore from the taxman too. A set of arrangements designed to meet the needs of domestic oligarchs in the 19th century proved perfectly suited to a new age of oligarchic capitalism.
But the non-dom rules also turned London into a tax haven for the bankers and other professionals who served the oligarchs and greased the wheels of the globalised financial system too. Nor was it just their worldwide income that was shielded from UK tax. Many European bankers were drawn to London with the offer of bogus dual contracts, whereby they claimed to be resident for only half the week. This enabled them to pay just 28 per cent tax on their salaries and bonuses, the rest of which were paid offshore. A 2022 study by the London School of Economics shows just how important non dom status has become. Between 2001 to 2018, 490,000 individuals claimed it at some point, equivalent to the population of Manchester, while in affluent areas of central London, 12% of residents had claimed non-dom status.
As the success of the City grew and inequalities widened, it is hardly surprising that public resentment grew. HMRC eventually cracked down on the egregious dual contracts. Then in the wake of the global financial crisis, Gordon Brown’s government introduced curbs to the non-dom regime, requiring anyone wanting to take advantage of the remittance basis to pay a charge. George Osborne as chancellor introduced further reforms which took effect in 2017, including scrapping non-dom status for anyone resident in Britain for 15 out of the last 20 years. But every move to reform the regime has prompted warnings from the City that it risks killing the golden goose that has laid magnificent golden eggs for the UK economy.
Golden Goose
And there lay the rub. Whatever the perceived unfairness of the non-dom regime, it had helped seed and nurture what had become a vast ecosystem that was generating huge wealth for the UK economy. It was not just the oligarchs and bankers themselves who were benefitting, but the swathes of people who served their needs and lived off the crumbs that fell from their table: the lawyers, the PR advisers, the architects and interior designers, the auction houses, restaurants, hotels and private jet providers. Financial and related services alone are estimated to contribute 12 per cent of UK gross value added and 13 percent of tax revenues. Why put that at risk?
Yet there was a dark side to this success. Some economists warned that the success of the City had left Britain suffering from “Dutch disease”, which takes its name from the damage caused to the Dutch economy in the 1960s when an oil boom led to such strength in the local currency that it made the rest of the economy uncompetitive. Did the success of the City strengthen sterling, thereby making life harder for UK manufacturing and contributing to the demise of industries outside London? What is certainly true is that the success of the City sucked talent away from other sectors, most notably the public sector, thus contributing to the hollowing out of the state.
A second concern was that the success of the City led to the “financialisation” of the UK economy, encouraging what economists call rent-seeking behaviour at the expense of productive investment. In most economies, financial services are considered a cost of doing business that produces nothing of value itself. But in Britain, extracting rents extracted from around the world has become the core of the national economic model. The City may not deliver much of value to the domestic economy - indeed small businesses complain that they cannot access the finance that they need to grow - but the rentiers are nonetheless central to national prosperity.
Dutch Disease
That the government has now decided to abolish the non-dom regime entirely is a sign of just how far public opinion has turned against the golden goose. In fact, public anger at the old economic model has been the driving force in British politics for years. Resentment towards the “global financial elites” was key to the Brexit vote which cut the City out of the single market. Public disgust at the tide of dirty money flowing forced the government to take steps to shut down the “London laundromat” in the wake of Russia’s full-scale invasion of Ukraine. That it should be the Tories that delivered the coup de grace is itself revealing, given that many of the party’s biggest donors and the proprietors of its media cheerleaders are non-doms.
How seriously should we take warnings that abolishing non-dom status will lead to an exodus of wealthy foreigners from Britain and so cripple the UK economy? Inevitably there have been similar warnings every time the system is reformed. But a 2022 study by Warwick University found no evidence to support them: the 2017 that abolished permanent non-dom status led to just 0.2% of long-staying non-doms leaving the UK. Among more recent arrivals, who had been in the UK for less than three years, around 2% left. It seems that fortunately for London, the cluster effect is strong and the lure of one of the world’s great capitals is hard for rivals to replicate.
Nonetheless, another key element of what made London so successful in the era of hyper-globalisation is being stripped away. Other jurisdictions in the Middle East and Asia offer more attractive fiscal regimes. The collapse of transactions in the London Stock Exchange, which is becoming a source of despair bordering on panic among bankers, may be a sign that London’s best days are behind it. Should geopolitical tensions lead to a much deeper fragmentation of global financial markets, the impact on the City could be profound. Many will welcome a cure for Dutch disease and shift away from financialisation. But if Britain is turning away from its old economic model, it does beg the question what will replace it?