Treasury’s analysis – Brexit will cause a significant downturn to the UK economy regardless of the deal agreed – 30/11/2018

3rd Dec 18

It’s impossible to push aside politics when it comes to Brexit, but even at this late hour the outcome of the UK’s negotiations with the other 27 countries is so uncertain that the only sensible option for businesses and their advisers is to consider the potential impacts of the three most likely scenarios on their business operations.

This is what the Treasury has done with the EU exit long-term economic analysis it published this week.

Likely outcomes

Speaking at a seminar hosted by app developer Figured in June, agricultural economist Sean Rikard predicted the ongoing uncertainties: “[Theresa May] wants to give certainty, but there can’t be any certainty until the final thing is agreed. The likely outcomes are likely to be that we stay in the European Economic Area (EEA) and Customs Union, with no voting rights. If there is no deal, we would go to a World Trade Organisation (WTO) regime. There would be tariffs and non-tariff barriers on all trade. If the government doesn’t win enough support, there could be an election or second referendum and we’d go back to where we started.”

As the Treasury released its report with just 118 days to go (at time of writing) until the Brexit deadline triggered by article 50, Rikard’s predicted uncertainty sees the UK teetering on the border of chaos.

Prime Minister Theresa May is boxed into a near-impassible political gridlock by the resistance of Brexit hardliners in her own party, her dependence on the 10 Democratic Unionist MPs who refuse to countenance any different treatment for Northern Ireland and the intransigent stance in Brussels, where negotiators are publicly saying there is no more room for manoeuver on the deal agreed with the other 27 countries.

The Treasury undertook forecasting work based on four different scenarios. Thanks to the fluidity of the negotiations, none of the scenarios actually matches the shape of the current exit agreement, but the options range from a milder option that assumes the UK is part of the EEA to a ‘hard Brexit’ (remember that term?) scenario if a negotiated agreement cannot be reached.

Unless you are an ardent Eurosceptic, it will come as little surprise to learn that the Treasury analysis shows that higher barriers to UK-EU trade would be likely to result in greater economic costs.

Nearest option to the current deal

The policy position closest option to the current proposals (the outline arrangements agreed at Chequers in July with subsequent amendments) would result in 3.9% less growth in GDP over the next 15 years, roughly equivalent to £100bn a year (according to estimates quoted by the BBC).

Potential fallbacks

Although not currently on the table, the Treasury considered the likely impacts of a free trade agreement with zero tariffs, and an EEA-scenario, which would mean staying in the Single Market, implementing new EU legislation automatically in its entirety, and continued free movement of people. This would be akin to the position of Norway in relation to the EU, and would be unlikely to meet the government’s commitments to ensure no hard border between Northern Ireland and Ireland, the study noted. The likely impact of the softer EEA scenario would mean 1.4% less growth over a 15-year cycle, while the impact of the free trade option outside of the Customs Union could reach 6.7%.

No deal

In the event that no deal can be reached, the Treasury based its assessment on average non-tariff barriers (NTBs) between countries trading on non-preferential World Trade Organization (WTO) terms and applying EU-applied ‘most-favoured nation’ tariffs. The ultimate impacts could slow down the UK’s economic growth by up to 9.3% over the term of the Treasury’s forecast.

Rikard likened this scenario to Canada’s status, where there is no access to the single market or the Customs Union. There would be no free movement of goods or people, and imports would be subject to duties and checks as they arrived.

The UK would be free to drop its tariffs and treat all countries equally until it signed free trade agreements with them: their tariffs would be applied in the interim. The UK would also have to reapply to become a member of WTO, as that status is currently achieved through membership of the EU.

“You don’t just join the WTO,” Rikard warned. “There are stages of membership. They would have to propose applying WTO tariffs and hope that no one objects.” With bitter memories of 1980s quotas, New Zealand is already voicing potential objections, he added.

Costs of leaving the Customs Union

Avalara vice president and VAT expert Richard Asquith is another astute observer when it comes to the likely impacts. He has sketched out the three-option model for the past two years and put the cost of leaving the Customs Union as high as €6bn a year: roughly €2-€4bn for running a separate customs operation and another 2bn or so for the impact of reduced trade.

As well as experiencing the inflationary effects of a falling pound – with which the UK is already familiar – the no deal option would mean the UK had to renegotiate countless EU standards agreements on issues as diverse as aviation, radioactive goods and medicine.

Brexit will mean more compliance and the loss of zero-rated intra-community supplies; imports that come in from the EU will be subject to 20% UK VAT and vice versa on exports, Asquith explained at the ICB conference earlier this week.

The controversial multi one-stop shop (MOSS) filings for UK businesses selling B2C digital items to consumers in the EU will also change. In the event of a no deal Brexit all affected business will have to register for Non-Union MOSS in one Member State or register for VAT individually in each of the member states where it is required to account for VAT. “A lot of businesses will just stop selling into Europe,” Asquith predicted.

On the bright side, he added, there will be some good news: “No more intrastat!”

Although the costs will be significant, Asquith took a more pragmatic view of the likely outcome for VAT after the two-year transition period planned from 19 January next year. “Nothing will happen. VAT accounts for 26% of our [tax] revenue. There’s no scope to cut it,” he said.

“The EU VAT system was set up in 1993 under what was meant to be a transition agreement, which still in place,” Asquith said. “The EU fudges everything, so it’ll just be another two-year transition period. However, transition isn’t the right word if you don’t know what you’re transitioning to.”

Do your Brexit homework

The Treasury economic forecasts make for heavy reading, and the issues don’t get any easier as you dig into the regulatory and tax detail surrounding Brexit. While promoting the analysis, Chancellor Philip Hammond repeatedly emphasised that only half of UK companies had prepared any contingency plans in case of a no-deal split from the EU.

As this brief summary may have indicated, there are multiple factors to take into account. At this stage, it would be prudent for any accountant in business or practice who has not investigated the effect of the different Brexit options to start doing so now. While the conclusions may be sobering, it is an ideal opportunity for the profession to act proactively and exert a calming, strategic influence.