Business | Investment
Are cities' tax coffers drying up?
Financial hubs such as New York and London suffer big losses in corporate contributions
- Financial Times
- Published: 23:51 August 22, 2008
The penny has dropped in London and New York that banks are not reliable sources of tax revenues. Losses from the credit crisis means that some investment banks may not pay taxes, as Michael Bloom-berg, mayor of New York, gloomily phrases it, "for years".
The most spectacular example is Merrill Lynch, which has booked $29 billion of losses from its rash involvement in trading collateralised debt obligations, in London. Although many of the deals in question were struck by bankers in New York, Merrill booked them to its London subsidiary.
As a result, London and the UK can forget Merrill paying any tax on its local profits for a very long time. Merrill Lynch International has accumulated tax losses that it will be able to carry forward indefinitely. The investment bank has become the institutional equivalent of a "non-dom", a foreign banker who escapes UK tax.
For Merrill and for the UK, this is an unintended consequence of the low rate of corporate taxation. The UK corporation tax rate of 28 per cent meant it made sense for Merrill to book the deals in London rather than the US, where the federal rate is 35 per cent and state taxes add a few percentage points.
Low taxation has now become zero taxation, which will further add to the incentive for Merrill to do (or to book) business in London. That has some benefits for the City of London in terms of employment but is unlikely to warm the hearts of the tax-paying British, or other UK-based businesses.
More broadly, it could prompt a reassessment of the benefits to cities such as New York, London, Dubai, Frankfurt and Hong Kong of competing to become international financial hubs. If a country gains some sky-scrapers and local jobs, but few fiscal benefits, it will become a less pliant host.
New York and London have depended heavily on banks to fill the coffers. Banks provide about 20 per cent of New York's state revenues and nine per cent of the city's funds. Banks such as Goldman Sachs have been able to exploit that status to obtain significant tax breaks on building and occupying skyscrapers in Manhattan.
After a period in disgrace with their shareholders and changing their senior executives, investment banks will be able to get on with business. But the hangover from the credit crisis will affect cities for years to come. They will have to find other sources of revenue to make up for the absence of taxes from financial institutions.
Financially based cities are facing the same challenges as others that were heavily dependent on single industries did in the past. The decline of western coal-mining, shipbuilding, steelmaking and car manufacture have afflicted cities such as Leeds, Glasgow, Sheffield, Pittsburgh and Detroit.
Investment banking is not dead but it is in a cyclical downturn. It has occupied an outsized role in western economies in the past decade and is now shrinking. This cyclicality, and its tendency to make losses every few years, make it an unreliable financial partner. Let the taxman beware.
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