Brexit: HMRC estimates “max-fac” model or “no deal” could cost £20bn

HMRC chief Jon Thompson made waves some weeks ago when he estimated that the proposed post-Brexit “highly streamlined customs arrangement” or “max-fac” option would cost the government between £17bn and £20bn.

He appeared in front of the Treasury select committee again to defend the figure, break down the methodology and run through the cost estimates of both of the government’s proposed models, as well as why a “no deal” scenario could also cost up to £20bn.

The two models

The “highly streamlined customs arrangement”, or “maximum facilitation” model, favoured by Brexiteers including Boris Johnson, David Davis, and Liam Fox, would attempt to ensure frictionless transfer of goods and minimise border checks through the employment of technology and trusted trader schemes.

Meanwhile, the “customs partnership” model, supposedly favoured by Theresa May, would see the UK collecting tariffs on behalf of the EU, and then appropriately refunding importers. This model would eliminate the need for customs checks.

Despite reports that the EU has branded both options “unworkable” in terms of avoiding a hard Irish border, the government has pressed on with various cost analyses.

Breaking down the potential costs

In the previous session with the Treasury committee, Jon Thompson said HMRC estimated the max-fac model would cost between £17bn and £20bn, while the customs partnership would be cost neutral.

The cost estimates were met with incredulity from various economists and government figures, including Jacob Rees-Mogg, who said it was “inflated”.

In front of the Treasury committee again, Thompson explained that the key driver of the cost difference was the volume of customs declarations that would be required by the max-fac model.

He explained that cost calculations could be made either using a top-down methodology, looking at percentage of value of trade, or a bottom-up approach, which looks at the volume and cost of declarations.

HMRC’s rationale for favouring the bottom-up approach was due to the fact that the top-down model assumes the nature of trade between UK and rest of world is similar to the nature of trade between UK and EU.

Thompson said that while the value of UK-EU trade, valued at £382bn in 2016, is similar to the value of UK’s trade with the rest of the world, at £393bn, intra-EU trade is lower in value but higher in frequency.

While currently the national customs hub in Salford processes 55m customs declarations annually, HMRC estimates that the max-fac model would require approximately 205m customs declarations, increasing costs due to the volume of declarations as well as by the demand for a larger workforce, which is currently comprised of around 750 people.

HMRC estimated that the max-fac model would on average cost businesses £32.50 per customs declaration, a figure that was reached by averaging estimates from three independent reports – one by Ipsos MORI in 2015, one by KPMG in 2018 for the Dutch government, and one from Nottingham University Business School in 2013.

The £32.50 figure was a weighted average of figures cited in those papers.

Thompson explained that the £17bn – £20bn figure would be broken down into £6.5bn each for the UK and EU in costs for customs declarations, and the remaining billions would be costs to businesses relating to EU regulatory measures.

He said while the customs partnership would bring costs in terms of administration of the dual tariff and administration for the repayment mechanism, he believed that overall it would be at a lower cost.

When queried on whether these figures had at all been challenged within Whitehall, HMRC representatives said that the figures had been circulated within Whitehall and gone through an “internal validation process and challenge process”, and had been quoted in ministerial papers.

In response to a question about the costs of a “no deal” scenario, which would see UK trade falling to WTO rules, Thompson said that it would likely be a similar cost to the max-fac model as it would also require customs declarations.

Will a functioning border be ready by January 2021?

Thompson repeated HMRC’s position that a functioning border will be ready by January 2021. He accepted that there would have to be some balancing of the government’s three key priorities – security, revenues, trade. He clarified that there would be a functioning border in place by this date, but not necessarily an optimal border.

While the government estimates a three year time period to implement the highly streamlined customs arrangement and five years for the customs partnership, he explained that the five year period for the partnership is primarily driven by the building of the tariff reclaim system, which is not necessary for a functioning border in 2021.

The only element of the border that perhaps would not be ready by 2021, according to HMRC, is ro-ro (roll-on/roll-off), which would equip ships with the mechanism to carry wheeled cargo, as opposed to the lo-lo (lift-on/lift-off) system. He said the extended time frame for this was due to the level of mutual cooperation required by countries to implement it.

How is HMRC preparing?

HMRC said its customs declaration service is on track to be fully functioning by January 2019. Thompson said it has been reviewed 15 times, and will begin roll out to traders in August. After heavy consultations with industry, Thompson said a system of three trenches has been decided to de-risk it, so this will be rolled out first in August, then November, and finally December. The current “chief” system is also being scaled up to be a full contingency if something were to happen to the customs declaration service.

Nicky Morgan, chair of the Treasury committee, also asked HMRC why reports said it had trimmed its workforce by 2,000 since the referendum, when clearly more support was required. Thompson clarified that this decision was undertaken by his predecessor due to the assumption that digitising services would reduce traditional contact, which he said was “overly aggressive”, as the reduction of traditional contact had not happened at the expected rate. He said that while employees in the customer service department had been decreased, the customer compliance department, looking at avoidance and evasion, would expand.

HMRC is also scaling back digital projects to release project capability to EU exit work.