TAC0013

Written evidence submitted by Social Enterprise UK

What is a social enterprise?

Social enterprises are businesses which have a legally binding social and/or environmental mission and trade to deliver that mission. They generate the majority of their income from trade, so are different from charities. They reinvest the majority of their profits back into delivering their mission, which makes them different from traditional businesses. They are majority controlled in the interests of their social mission, which means that shareholders and other stakeholders do not have priority over decision making.

This definition is not just limited to the UK and is in line with the international definition of social enterprise developed by the Social Enterprise World Forum.

More information can be found online.

Size and scope

Social Enterprise UK

Social Enterprise UK is the national body for social enterprises and has over 2,500 members. We collect data, provide policy support for government and practical help for social enterprises.

 

Executive Summary

The UK needs to take a fresh approach to taxation following COVID-19. Rather than treating the economy and society as something “static” from which revenues are generated in order to provide public goods and correct negative externalities, HM Government must use tax as a tool to shape positive economic and social outcomes.

Without this change of approach continuing fiscal instability and poor economic performance is inevitable for the UK, particularly given the UK experience over the past decade.

There are three key changes which the HM Government must adopt post COVID-19.

1)      A set of strategic goals to govern the tax system – these are economic, social and environmental outcomes that HM Government wishes to deliver, and which should govern tax policy and tax changes.
 

2)      A change in culture with a greater tolerance for risk – poor economic performance of the past decade combined with growing demand for public services means that new approaches are required. This will require a different culture within HMRC and HM Treasury which have a strong status quo bias.
 

3)      Better methods of evaluation of tax policy – financial impact is only one lens through which tax policy should be seen. Social, economic and environmental considerations need to be taken into account. HM Treasury can learn from the changes that have taken place in government procurement where a more holistic approach has been taken, expanding the opportunities for public spending to positively shape communities. Taking a “social value” approach to tax will be critical to rebuilding the UK following COVID-19.

HM Government needs to rediscover the power of taxation to shape the economy. Creating positive economic and social outcomes alongside higher levels of growth will lead to a reduction in the deficit and a more sustainable fiscal pathway for the UK.

For business, the UK tax system should encourage behaviours which we know are likely to lead to better business performance. Unfortunately, up to now the UK has pursued a path of “neutrality” when it comes to business, which has seen the UK fall behind global competitors. A better approach would be to use targeted tax changes to encourage productive investment, investing in people and promoting forms of business which have the right structures to promote long term thinking, such as social enterprises. This would add to tax complexity, but if it improves economic performance, this will outweigh any costs.

The UK currently under utilises tax to shape economic and social outcomes. Although there are some large tax reliefs such as VAT reliefs on building new homes or public transportation, this passive approach does not address the core issues around the UK’s economic performance. Rather than taking a “sectoral” approach HM Government should encourage positive business behaviours which will address long term challenges.

The rest of the submission considers three practical changes which could be implemented within a refreshed tax system:

a)      A “Human Capital Allowance” to encourage investment in people;

b)      Full expensing of capital investment to encourage productivity growth;

c)      Business rate relief for social enterprises and cooperatives to encourage better forms of business.

Resetting the tax system in the post-COVID age

As the Treasury Committee has noted the UK tax system has been fundamentally unchanged for the past several decades. Given the significant changes that have taken place in the UK economy in recent years now is the time for a fundamental shift in the tax system and strategy within the UK. There are a number of fundamental challenges which need to be addressed in the wake of COVID-19:

Although these priorities are clear to HM Government, they do not govern out tax system which operates a parallel policy sphere. This bifurcation has to end.

The UK tax system needs to be reformed in several difference areas in the wake of COVID-19.

Firstly, HM Government needs to develop new strategic principles governing our tax system. In 2011, the Treasury Committee’s report on the principles of the tax system identified four principles for the tax system: sustainability of the public finances, efficiency, fairness and value for money.

There was minimal consideration given to the impact of taxation in driving the social and economic priorities of the country. Currently, the strategic principles underlying tax policy assume a relatively static economic structure for the UK, seeking to maximise revenues for public services within this economic structure with the least amount of resistance (either economic resistance such as fraud or through political opposition). This is flawed and creates numerous inconsistencies and weaknesses in our tax system.

The irony is that focusing on the “first order” strategic challenges to the UK noted above (e.g. Net Zero, productivity etc.) will address the “second order” principles which have up to now been the driving force around tax policy (i.e. generating revenue and fairness within different stakeholders). For example, using tax policy to boost productivity will generate revenues which will help to close future deficits and boost living standards through increases in wages. Encouraging carbon negative business behaviour will reduce the future cost to the Exchequer from climate change.

HM Government’s current approach to use tax primarily as a lever to generate funds for public spending, which in turn is used to pay for public goods and to offset negative externalities, has created an unsustainable fiscal position where public sector debt is due to reach 200% of GDP by 2050, according to the OBR. Unless the HM Government is able to restructure the UK economy either to sustainably operate at higher levels of growth (through increased productivity) and reduce long term demand for public services and spending, then this fiscal position can only worsen.

Linking tax policy to structural reform of the UK economy has never been more critical and means ending the artificial division between HM Government economic policy and tax policy. 

Secondly, tolerance to risk needs to changed. The lack of a clear direction or set of strategic economic principles in tax policy has made the primary policy making institutions, conservative and risk averse. Some of this is understandable given media pressure and the political ramifications for failures in tax policy. However, the lack of a strategic direction means that there is little tolerance for changes which may have a low level of risk but could have significant upsides for the UK economy over the long term.

Social Enterprise UK has had direct experience of this in discussions with HM Government about how to support the growth of the sector through the tax system.

A lack of understanding by officials about what HM Government’s strategic direction for the UK economy and society creates a culture whereby officials prefer to maintain the status quo rather than consider alternative approaches which carry risk of failure. However, by not considering alternatives, HM Government remains locked in an unsustainable position.

A clear set of strategic goals will make it easier for officials to give advice and for Ministers to make judgements on whether the risks outweigh the potential gains in supporting the UK’s economic and social aspirations.

Finally, there is a need to adapt evaluation and measurement of tax policy. At present tax policy is almost exclusively evaluated on the basis of financial impact. This is generally quantified in terms of revenue raised, cost to businesses, cost of implementation etc. Even here, the National Audit Office found in its 2014 review of tax reliefs that very few tax reliefs were evaluated. Other tax policy changes (such as the significant reductions in corporation tax or changes to business rates) are rarely, if ever, reviewed by the state.

More rigorous evaluation and measurement of the effect of tax policy is essential to pursuing a more targeted approach, but financial cost and revenue are only part of the picture.

Here, HM Treasury and HMRC should learn lessons from the government’s change in approach on procurement. Up until recently, the focus in procurement was purely on financial cost and value for money in a narrowly defined sense. Now, HM Government has embraced a more holistic view of procurement through the development of social value (including within it economic, social and environmental impact) when commissioning and procuring goods and services.

The logic is that procurement which seeks to generate positive social and environmental impact alongside positive spill over effects will save the Exchequer over the long term through reducing long term demand for public spending and improve the living standards of the population which is the primary political goal of most governments.

A similar approach to embed social value into the tax system is essential so that better decisions are made about tax policy. This will require additional expertise within HM Treasury and HMRC. It would also ensure a more joined up approach between different policy departments and tax system. A more joined up approach between Cabinet Office and HM Treasury/HMRC could lead to better outcomes.

Utilising the power of the tax system to improve our society

Taxation is the flip side to spending. Although the UK has been running a deficit, the Government still generally seeks to raise almost as much in taxation as it spends. This means that currently around £870bn is raised in tax, 38% of UK GDP. On top of this, the UK has over 1,100 tax reliefs which forgo revenue of over £400bn a year – equivalent to 18% of GDP. The UK is also losing over £100bn a year in lost revenue due to tax avoidance according to experts such as Tax Justice UK. This avoidance and evasion is around 4.5% of UK GDP. In total, tax receipts, tax reliefs, tax evasion and tax forgone are equivalent to over 60% of UK GDP. Tax shapes our economy to a degree which is largely unrecognised within HM Government and the UK policy community.

For example, the decision over previous decades to focus on expensive top-line corporation tax reductions has disproportionately benefited large multinational businesses and financial services. Tax policy is part of the reason why we have the economy we do. Yet there has been little impact or analysis of the impact of these significant tax experiments.[1] At the same time we have been spending public money on programmes (e.g. expanding apprenticeships) which are being undermined by parts of our tax system (e.g. a less generous discount rate for capital investment).

Policy makers need to rediscover the importance of taxation in shaping the economy beyond consideration of the overall level of taxation and spending. There is no clear evidence that there is a correct “level” of taxation. Different economies have different levels of taxation and spending depending on their history, values, political cultural and economic structure. Yet much of the debate on taxation is focused on the right “level” rather than whether the system of tax that we have in the UK generates the right social and economic outcomes. This is a shift in thinking that politicians, institutions (such as HM Treasury and HMRC) must make.

Revenue and economic performance

The Treasury Committee has rightly raised concerns about the sustainability of tax revenues and erosion of the tax base. The need for revenues in order to provide public services, public goods and to correct negative externalities is clear. However, history tells us that tax revenues are effectively tied to overall levels of the growth and productivity in the economy. Since the Great Recession and the slow recovery from its effects, the UK has found its tax revenues out of balance with spending. Despite “austerity” there the UK has been running a budget deficit and now is entering another period of expansion in public spending without having effectively raised revenues. The Institute for Fiscal Studies and other bodies have repeatedly noted that the UK has a systemic inability to raise the revenues required noting the desire for “European-level of public spending” with “US tax revenues”.

A greater focus on lower spending and tax sustainability over the past decade has not clearly led to any improvement in the UK’s tax position.

Tax policy should focus on supporting the economic and social objectives of the government, with a view to raising revenue necessary to maintain those objectives.

Although this should not stop HM Government from considering matters of fairness and equity between different forms of economic activity, the more worrying “erosion” is the lack of growth across the UK economy as a whole rather than individual sectors. In effect this is the difference between generating hundreds of billions of additional tax revenues in the decades ahead or several billions from particular forms of business.

Tax policy has a role for generating the conditions for growth and better economic and social performance which is currently underutilised. Addressing this issue will leave the UK in a better position to consider other strategic challenges.

Simplification and tax strategy

The Treasury Committee asks whether there are “areas for simplification” in the tax system and for a long time it has been the objective for HM Treasury and HMRC to “simplify” the tax system. Politically speaking this has been reinforced through the creation of the Office for Tax Simplification. Whilst a “simple” tax system is an ideal and taxes should always be designed with a view to being as easy and cheap to administer as possible, there is no clear rationale for why simplification should be an overriding objective for the tax system.

Arguably, the object of “simplicity” has now become another cultural barrier to using tax policy in a more strategic way as officials and Ministers have used “complexity” as an argument in favour of the status quo. SEUK has directly experienced this over the course of the past year around discussions over the future of the Social Investment Tax Relief, where “simplification” has been used as a rationale for removing this tax relief even though this relief has generated tens of millions of investment for some of the most deprived communities in the UK – in line with HM Government’s “levelling up” agenda. 

There is also no clear economic argument in favour of simplification as a good in itself. Economic and business literature is often able to give a theoretical justification why simplification is good for the economy, for example driving lower transaction costs and reducing distortions. Yet competitor economies often deemed to have as complex or even more complex tax systems (United States, France, Germany, Israel) are seeing better economic and social returns in terms of levels of productivity and living standards. This runs against the advocates for simplification which would surely argue that greater complexity should see lower returns.

Any developed economy is inherently complex and delivering outcomes such as higher levels of productivity, higher living standards, reducing regional inequality are also inherently complex. The state needs to use all the tools at their disposal, including tax, to promote those behaviours and actions which have the best chance of success. Simplicity can be a barrier to achieving this as it encourages blanket changes (such as reductions in corporation tax) which see businesses or individuals “rewarded” with little or no value created from those tax reforms. More targeted policies are required governed by a coherent policy framework.

Rather than focusing on “simplicity” the aim should be to experiment regularly within an overall strategic framework aimed at growing the economy with a view to reducing social inequality and combating climate change. Clarity around the goals of tax policy would deliver better results and arguably open the door for simplification (by creating the political space to reform tax reliefs and exemptions which do not effectively drive the strategic goals) rather than focusing on simplification as a goal in itself.

Using tax to change business behaviour to boost the economy

As noted above, one of the biggest challenges to the UK will be rebuilding our economy after COVID-19 in a way that boosts productivity and long-term growth. Without this, the fiscal position of the UK will worsen and become potentially unsustainable by the end of the century. 

Tax changes by themselves do not create growth. It is what households, entrepreneurs and businesses do in response to tax changes that creates the conditions for growth. This explains the puzzle of why large-scale corporation tax cuts between 2010-2018 did not create significant growth in the UK despite the prevailing economic consensus. HM Treasury and the OBR have been consistently “surprised” at the lack of business investment over this period despite tax reductions. A lower rate of taxation did not lead to additional investment or job creation because most UK businesses were happy to take the additional money and distribute it owners and shareholders, or to keep the cash in the bank. This was a “simple” tax policy which had poor results.

The last decade has showed that a “simple” focus on the levels of taxation (e.g. corporation tax, business rates etc.) rather than the structures and incentives created through the tax system is flawed. A more targeted approach is required.

There are parts of the economy and types of businesses that have showed the characteristics of a “good business” where there is focus on long term investment, providing good jobs at decent wages and which generate significant social and economic value for the UK economy. These businesses, if given additional support through the tax system, are highly likely to use any financial benefits in a way that generates jobs, growth and opportunities for the UK.

Inculcating and rewarding these behaviours through HM Government policy is critical to bringing the UK’s fiscal position back into balance.

Backing “productive” business – a cross-cutting tax strategy

As Nobel Prize winning economist Paul Krugman put it, “productivity isn’t everything, but in the long run, it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

Productivity can be measured in numerous different ways but a consistent proxy is GDP per hour worked. Either comparing over time or between different countries, the UK has experienced an unprecedented productivity slowdown. This in turn has led to an unprecedented squeeze in wages, reducing the living standards of workers.

The UK has already sought to address the productivity challenge through numerous spending initiatives including a £31bn Productivity Investment Fund, a commitment to boosting public investment in infrastructure and a new “DARPA” like body to fund new technologies.

However, on the tax side there has been little change to tax policy in recent years to support productivity. The Annual Investment Allowance has been tweaked and changed by different Chancellors since 2010. The “R&D Patent Box” is a genuinely new invention but this has struggled to get mass take up with only 3% of eligible businesses taking part according to tax advisory MPA. The Patent Box further costs around £1bn per year – around 1/30th of the UK’s Productivity Investment Fund. This demonstrates the imbalance between spending and tax policy in delivering the UK’s economic strategy.

Boosting productivity must be one of the central aims of the UK’s tax policy and has the potential to also address other challenges such as the levelling up agenda and the Net Zero challenge

The rest of this submission will consider how this could be achieved within a refreshed UK tax strategy.

Supporting the right characteristics through targeted tax reductions and tax reliefs

The drivers of productivity are multifaceted but can be broken down into five main components:

Labour composition is effectively the quality of the workforce. In short, the more workers that are higher skilled, the more productive a business or economy will be. Labour utilisation is ensuring that labour is effectively deployed and is maximising the value of working hours. Moving staff from a low value creating role to a higher value creating role will increase productivity. Capital intensity is how much “equipment” accompanies a worker, generally speaking the more or better quality equipment per worker, the higher their productivity. This also includes public investment and public infrastructure. Together these three factors are the “standard” measurements of productivity within any economy or business.

However, these factors alone do not count for productivity increases. There are two other main factors behind productivity increases. The first is technology and the adoption of technology. Breakthroughs in technology clearly boost productivity but more importantly is adoption of new technologies. Without widespread dissemination, technological breakthroughs will not benefit the wider economy. Although this is partly related to capital intensity it is not fully covered by this point. For example, a farm could improve its productivity through buying more or better-quality manual drive tractors and eschewing newer and more productive automated tractors (perhaps due to perceived risk or cost). There is widespread agreement in economic literature that technological adoption is important to long term productivity growth.

There is less agreement for, but a growing body of evidence, that culture and organisation of businesses and the economy are also an important factor.[2] Businesses which lack the right “culture” will fail to invest or perhaps even take resources out of the company in order to boost profits. Within the UK as a whole, it has been noted for decades that there is too much “short-termism” in decision making when compared to competitors such as France and Germany. Raising productivity is an intensive and long-term process and requires the UK to develop more businesses with the right structures and cultures.

Considering the above tax policy should support businesses which:

a)      Invests in their workers

b)      Seeks to create greater value with its workers

c)      Invests in new capital and equipment

d)      Innovates, invents or adopts new technology (including new processes)

e)      Has the right structures and culture for long term productivity gain

Our tax system does try to support some of these characteristics. For example, the Annual Investment Allowance does provide a tax incentive for those investing in new equipment and machinery.

However, of over 1,100 tax reliefs in the UK only 128 (around 11%) are targeted to positively influence behaviour of individuals and firms. The NAO has found that HMRC and HM Treasury have often poorly defined what tax reliefs are supposed to achieve, and although the NAO has estimated that these have a significant cost (over £100bn or 11% of the UK Budget) around 1/5th of tax reliefs aiming to generate a positive social or economic change are attributed to one tax relief - pension tax relief.

Capital allowances for example, cost HM Government less than 5% of the total spent on tax expenditures. A significant portion of the other tax reliefs that are used to shape social and environmental outcomes are to related to philanthropy, rather than targeted at influencing positive economic outcomes of business.

There is a clear case to be made that more could be done by HM Government to do more to make use of targeted tax reliefs rather than generalised reductions or simplifications which show little to no evidence of success. 

There are also some tax reliefs or tax reductions which do nothing to create or encourage the characteristics noted above and which would arguably disappear if the UK had an effective set of goals or principles underpinning its tax strategy. For example, the Entrepreneurs Tax Relief, which encourage people to sell their stake in businesses, when most research indicates that we should be encouraging long term ownership and participation in business ownership. This could be scrapped or alternatively reformed to encourage entrepreneurs to transition their business to better forms of business (such as cooperatives and social enterprises) which show better characteristics for performance.

The rest of this paper considers some proposals that exemplify how a more strategic use of the tax system could help to boost the economy following COVID-19 and how these could work within an overall system of using tax to drive certain economic, social and environmental goals.

Investing in workers – using tax system to rebalance human and physical capital

Between 2010 and 2015, labour productivity in the UK grew by just over 1% compared with over 10% between 2000 and 2010. We need to upskill our workforce to improve our productivity and competitiveness. Investing in advanced robotics and AI will go some way to improve the UK’s productivity but we cannot ignore the need to improve the UK’s labour force which is a critical part of the UK’s economic performance. Moreover, given the UK’s economy is predominately based on services, the importance of a highly skilled workforce is vital.

In addition, a highly educated workforce is essential to improve our domestic market. Pay growth in the UK has been at the lowest level since the late 19th Century which is hampering growth both in the service economy and in other sectors such as the automotive industry. Although pay has started to pick up in recent months this is due to a tighter labour market not increased productivity. COVID-19 threatens to push this backwards with large scale unemployment likely to further empower employers who want to keep wages down.

Higher productivity and living standards are one of HM Government’s priorities in the “levelling up” agenda. Yet the tax system does not properly incentivise this activity.

Currently, there is no tax benefit to investing in workers over non-human capital. Taking two companies of similar size, the current tax system does not decisively reward investment in human beings over capital. Broadly speaking over a ten-year period, the rewards to businesses through the tax system investing in either would be roughly the same. However, the benefits to businesses through investment in capital over staff are higher when you consider:

As a consequence, the current system does not reward human capital investment and encourages a lack of investment into people, driving lower levels of labour productivity compared to competitor economies.

There is also a clear correlation between non-human capital and human capital investment. Purchasing new equipment generally means upskilling staff to use such equipment and to maximise the gains generated through capital investment. However, as noted above, there is little tax incentive for investing in staff and this may lead to businesses opting not to invest in capital equipment as well because they cannot afford to both upskill staff and exploit capital investment. This may explain why the UK continues to suffer from low productivity compared to other countries.

The government needs to encourage investment of both human capital and non-human capital if they want businesses to make the most of automation and AI. HM Government cannot disincentivise non-human capital investment over human capital investment in order to rectify the balance because the UK also needs investment across the board. Physical capital allowances need to be maintained (or even expanded, see below) but extra incentives need to be given to human capital to ensure balance.

HM Government could create a Human Capital Allowance to match the special Capital Allowances and Annual Investment Allowance which currently exist in the tax system.

The Human Capital Allowance could come in two main forms:

The “Employment Allowance” style approach would be more attractive for employers as it would directly reduce a fixed cost and ease cash flow. This would be the option most likely to help employers. The Human Capital Allowance would complement the Apprenticeships Levy which currently forces employers to put aside a certain amount of money for funding accredited apprenticeships.

The costs covered by the Allowance would go beyond the training and development costs which can already be written off for tax purposes but which are only a small part of the overall costs for business. Examples include:

The Human Capital Allowance would be set at a fixed rate every year (with a cap dependent on size of employer and sector) or could be based on a fixed percentage of payroll, similar to the Apprenticeships Levy. The Human Capital Allowance could be further enhanced by tying it into existing proposals such as the DWP’s new allowance for employers that hire people with a disability or are vulnerable in other ways e.g. having been in care, ex-offenders, recovering from mental illness etc.

A “high investment” economy – full expensing of capital investment[3]

 

Full expensing of capital investment has been proposed in outline by numerous business groups for several years.

 

Full expensing’ means letting businesses deduct the cost of any investment they do from their corporation tax bills straight away. At the moment, for ongoing expenses like pens and paper, businesses can do this already. But for longer-term expenses, like investments in a new building or in new machinery, they can only deduct a small fraction of the cost of investment each year over the accounting lifespan of that investment.

This means that, in fact, businesses don’t actually get back the full cost of the investment. £100 today is worth more than £100 in ten years because of inflation and the things (like other investment) you could have done with the money in the meantime. The longer the deduction period lasts, the less of the cost of the investment you can write off.

Between 2008 and 2013 the UK reduced the value of deductions for machinery and property — from 87.5 percent to 84 percent for machinery, and from 59.2 percent to zero for industrial buildings, so corporations cannot write off the cost of investing in buildings over time at all.
If we allowed businesses to deduct their investments from their tax bills immediately, we’d effectively be allowing them to deduct the full cost of those investments, with corporation tax no longer disincentivising investments in tangible capital.

Research by Eric Ohrn looks at states that adopted a full expensing policy temporarily in 2002 and 2008. Using a quasi-experimental approach, Ohrn finds that full expensing increased investment by 17.5% and grew wages by 2.5%. Five years after the full expensing window had been available, states that adopted it had 7.7% higher employment levels than comparable States that did not adopt it, and 10.5% higher production output (which means lower prices too, though not necessarily concentrated in that State).

This is such a large result that it sounds unbelievable, but is consistent with an Oxford University paper that looked at UK evidence as well, specifically the introduction of a policy that allowed small- and medium-sized firms to write off more of their investments in plant and machinery early on. This was not full expensing, but closer than before — a 40% write-off in the first year instead of 25%. Among eligible firms, compared to similar firms that were not, access to more generous capital allowances increased investment by 11% (2.1%–2.6% percentage points). This is roughly consistent with the other paper (where the policy was more generous), and still shows a large effect. Both seem to suggest a high elasticity of investment, where every extra pound raised results in much less investment.

Estonia’s system of cashflow taxation, which is equivalent to full expensing, has helped to give it the most competitive tax system in the developed world, even though its headline rate of 20% is higher than that of many others, including the UK’s. In the four years after introducing full expensing in 2000, along with other reforms to its corporation tax, investment growth was 39 percentage points higher there than in its Baltic neighbours.

 

Following Estonia’s example, the simplest way to do this would be to make the Annual Investment Allowance unlimited for all businesses. This would reduce Corporation Tax receipts by around £18 billion according to estimates by Sam Bowman and Stian Westlake. Over the long term, this policy would be fiscally positive as it would lead to higher levels of investment and growth compared to existing rates.

 

However, the cost could be offset by increasing the main rate of Corporation Tax – this would also have the positive effect of making the value of capital investment higher for businesses relative to distributing profits. This would further advance a tax strategy which shapes the economy and rewards positive business behaviour rather than generalised reductions or changes.

Encouraging the right culture and structures – supporting social enterprises and cooperatives to boost productivity and growth

There is currently no tax support for social enterprises as businesses in the United Kingdom. The Social Investment Tax Relief is a support for investors, but social enterprises do not directly see any financial benefit from that tax relief. This compares with the charitable sector which not only gets access to Social Investment Tax Relief but also Gift Aid and Business Rate Relief that provide a direct financial subsidy to registered charities.

Social enterprises do not need, and should not receive, the same level of reliefs as charities. Charities are wholly for public benefit. Social enterprises are a combination of public and private benefit. Charities cannot pay dividends. Some social enterprises can pay dividends.

However, a binary system where you are either a business and receive no reliefs (beyond small business or rural rate relief), or you are a charity and receive a large amount of relief is not sustainable and does not reflect the nuances of our growing social enterprise and cooperative sectors. It also effectively leaves our tax system neutral when it comes to different structures of businesses despite the growing body of evidence that there are benefits from worker ownership and having a social mission governing the organisation, rather than a pure focus on profitability.

Social enterprises and cooperatives are forced to compete with one hand tied behind their back compared to other forms of business. On the one hand, they are trying to generate the same level of impact that charities provide to communities. This creates additional costs, as social enterprises work in the toughest markets, often hiring people far from the labour market and using local supply chains or more sustainable materials for their products. At the same time, social enterprises and cooperatives are trying to compete with private businesses providing goods and services. These businesses are not seeking to generate social impact and do not have the same cost burdens as social enterprises. The creativity and innovation of social enterprises has created viable businesses, but without recognition of their social impact through the tax system they are unlikely to become mainstream in the near future.

Government has an opportunity to accelerate the growth of social enterprises through the use of the tax system. The benefits to government are multifaceted. As noted above, more social enterprises mean more businesses focused on delivering the government’s agenda around employment, levelling up, saving the high street and net zero. Now more than ever, the government needs to seed and grow thousands of business allies to deliver its agenda.

There is also long-term benefit to the taxpayer and the state. Repeated research has shown the value of early intervention and prevention. Social enterprises are helping to reduce future demand for acute services (in health, welfare and the criminal justice system) through their work. Social enterprises do this through numerous methods, tailored to the unique situations they encounter. Social enterprises provide employment, fund projects to tackle the causes of social challenges and collaborate with charities and private businesses to deliver change. Cooperatives are also creating social value through their investments into the communities that they work with and the fairer distribution of their profits. All this empowers communities and creates greater capacity within places.

Furthermore, social enterprises and cooperatives embody the long termism and responsible business behaviours that evidence suggest lead to higher growth and investment over the long term. The Government’s own report found that mission-led businesses where better placed for growth than other forms of business. A review on behalf of HMRC found that cooperative businesses were more productive than other non-worker owned businesses. There is enough evidence to justify a tax policy which favours forms of business which have a track record of success.

The most effective tax relief would be a reduction in business rates as this would reduce their fixed costs further freeing up cash that can be better invested elsewhere to grow the business and its impact. This rates relief would sustain higher levels of employment, more investment in equipment and products as well as free up resources for social impact. Based on the cost of the charitable rate relief, a social enterprise relief for Community Interest Companies and Community Benefit Societies would cost around £300-400m a year – a significant cost but far outweighed by potential gains through growth of the sector.

As with the examples above, a more targeted approach to tax policy would seek to shape the economy to deliver certain outcomes rather than assume that markets, left unguided, will produce optimal outcomes. The benefits over the long term from “better business” would far outweigh any initial cost to the policy and would reduce demand for public spending in the long term.

August 2020

 

 


[1] See Bounce Back Britain, O’Brien, June 2020

[2] As an example, see The Business Case for Purpose, Harvard Business School Review, 2015

[3] This proposal is taken from Stian Westlake and Sam Bowman’s Reviving Economic Thinking on the Right