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Why corporation tax cuts are a waste of money

A new study shows that George Osborne’s tax cuts will do little to create growth and jobs.

Whenever George Osborne is asked to produce something resembling a growth strategy, he cites his plan to reduce the headline rate of corporation tax to 23 per cent by the end of this parliament (it fell from 28 per cent to 26 per cent in the Budget).

Osborne recently boasted to the Institute of Directors that his decision to "very aggressively" cut corporation tax had been "noticed around the world". The Chancellor's hope, presumably, is that his tax cuts will revive an economy that, under his stewardship, has not grown for six months.

But today's TUC report on the subject, written by Richard Murphy of the excellent Tax Research UK blog, suggests that there is only a weak relationship between tax rates and growth. The study, which looked at OECD member states between 1997 and 2010, found that at most 7 per cent of growth differences (see graph below) can be explained by differences in tax rates.

In other words, 93 per cent of the variation is explained by other factors.

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As Murphy writes, "Tax rate differentials of between 27 per cent and 40 per cent over a period of 14 years are clustered so weakly around growth rates that these growth rates only vary between 1.9 per cent and 2.3 per cent per annum as a result."

He excludes Ireland and Luxembourg on the grounds that "the first two are both small states and tax havens" and excludes Japan and Italy on the grounds that they "have suffered such low rates of growth that they cannot be compared to the UK". In the case of employment (see graph below), just 6 per cent of the variation is due to differences in corporation tax rates.

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Murphy's persuasive conclusion is that scarce resources should be devoted to policies that have a significant, rather than a marginal, effect on growth and jobs. Reducing corporation tax to 23 per cent is a poor use of £4.5bn. Osborne's tax-cutting agenda is founded on political dogma, not economic evidence.

PS: As I've noted before in a Data Hound column, there is no reason to believe that a corporation tax rate of 28 per cent was damaging the UK's international competitiveness. The US, for instance, has a headline rate of 39.25 per cent and Japan has a rate of 39.5 per cent.