The Conservatives’ U-turn on corporate tax rates is a mistake
The big announcement to come out of Boris Johnson’s appearance before the CBI on Monday was that the Tories are abandoning planned a reduction in the corporation tax rate from 19 per cent to 17 per cent.
The reasoning behind this is that the tax cut was expected to cost the government £6bn, which Boris said could be spent on the NHS or other services. This is a mistake — for a number of reasons.
First, it calls into question one of the main arguments put forward previously by the Prime Minister in terms of tax cuts, namely that they bring in more revenue, not less.
As the Laffer Curve shows, there is an optimal rate at which to set certain taxes. Where that point is exactly may be up for debate, and there are obviously other factors at play. But by portraying this as a straightforward calculation (cancelling the tax cut will “save” £6bn), Boris has undermined his own party’s argument that lowering tax rates can actually increase tax receipts, by encouraging profit-generating activity.
More specifically, corporation tax is one of the most damaging taxes on the books. Taxing capital is generally a bad idea as it is so mobile. People can simply up sticks and move — and take their money with them — unlike the case with taxes on property.
As such, an uncompetitive corporation tax rate can put the country at risk of capital flight, leading to a black hole in the public finances.
And the damage done by corporation tax does not stop there. This tax acts as a disincentive for businesses to invest, leading to slow productivity growth. As increasing productivity is the main way to boost economic growth and raise living standards, anything that acts as a barrier to investment is a bad idea.
Then there is the fact that the current system encourages a bias towards debt. For example, if a business decides to fund a new project or development through borrowing, it can deduct interest repayments from its tax return, leading to a lower bill. However, if the company decides to finance its activities by selling shares, it can’t deduct dividend payouts as a cost — meaning a higher tax bill.
This results in a shift in the debt-to-equity ratio, and affects the capital structure of firms. The danger is that businesses become overly leveraged, so any downturn in the economy could have disastrous consequences.
Finally, despite what Labour might tell you, high corporation tax isn’t good for workers. Ignore the people versus business narrative — time and time again, the academic research has shown that the burden of corporation tax is borne by workers themselves, as it effectively lowers wages.
It is therefore disappointing that the Conservatives have jettisoned plans to reduce the rate. However, it’s not the end of the world, as long as it leads to a broader rethink about the best way to tax businesses and spur investment.
When the Conservatives started cutting the headline corporation tax rate in 2011, they also made changes to how capital expenditures were treated. The government reduced the value of depreciation deductions for investments in machines and industrial buildings, effectively increasing the effective marginal tax rate on new investment. This meant that many of the economic benefits of the supposed tax cut were not even realised.
If Boris wants to keep the good press he’s received this week about cancelling this tax cut, he should consider reversing these changes, along with making the Annual Investment Allowance — a tax break for business investment — unlimited.
Increased investment will improve our sluggish productivity and ultimately lead to higher economic growth and a better standard of living for everyone — all while enabling the Prime Minister to avoid accusations from Labour that he’s cutting tax for “wealthy businesses”.
Big businesses may be easy targets for politicians, but heed the warnings of Milton Friedman: businesses do not and cannot pay taxes, only people do.
Main image credit: Getty