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17 October 2022

Why higher corporation tax is good for growth

The British tax system is biased towards services, and a higher headline rate could redress the balance.

By Will Dunn

Since the market turmoil caused by the announcement of the government’s debt-driven Growth Plan on 23 September, Liz Truss and her new Chancellor, Jeremy Hunt, have reversed most of its measures, reducing the promised energy market intervention from two years to six months and abandoning almost all of the tax cuts that had been planned.

Of these cuts, perhaps the largest single item on the balance sheet is the decision that planned rise in the headline rate of corporation tax from 19 per cent to 25 per cent will go ahead. Scrapping the 45p top rate of income tax was hugely divisive, because it handed benefits worth tens of thousands of pounds to the highest earners in the country, but its cost was relatively low at an estimated £2bn. Treasury estimates put the cost of the corporation tax cut (or rather, non-rise) at £15.4bn.

But the headline rate of corporation tax itself was always a performative policy: it doesn’t really determine how much businesses pay, and it really doesn’t determine how much they invest. It’s a number that has been misused by both the left and the right in the aftermath of a disastrous fiscal event.

Free-market libertarians claim that the toad – tax – squats on the economy, soiling with its sickening poison the bold spirit of growth. But a low tax rate and high growth are far from correlated. Just ask Ireland, which appeared to book huge gains in GDP that never made it into real incomes. The International Monetary Fund found that two thirds of foreign investment attracted by Ireland’s low corporate tax rates was “phantom capital” that did nothing for the real economy.

On the left, much has been made of the fact that the UK has slashed corporate tax over the decades. It is true that if you look at a chart of the UK’s headline rate, it toboggans towards libertarianism, from 50 per cent in the early 1980s to 30 per cent by the turn of the century to 19 per cent in 2017. But at the same time, the tax base – the things that can be taxed – has broadened, and it’s the question of what gets taxed that is more important.

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Dan Neidle, founder of Tax Policy Associates, pointed out to me that despite the drop in the headline rate over the years, the actual amount of tax paid by corporations hasn’t fallen by much: “We can look at the total corporate profit across the economy in the national accounts – gross operating surplus, as it’s termed – and you can divide the taxes being collected by the gross operating surplus… And you see an amazingly constant overall rate since the late Seventies.”

Within that constant rate, however, something very significant has happened. The amount of tax taken may not have changed much, but it now comes from a very different set of businesses. As the tax base expanded, tax reliefs became much more important.

“People who rely more on reliefs have lost out, and people who don’t, won,” Neidle explained. “So in particular, industry has lost out, because they used to rely heavily on industrial buildings allowance, and write off the expenses of manufacturing machinery. On the other hand, the service sector, which doesn’t need that, has just benefited from the lower rate.”

In an economy that is unbalanced and made vulnerable to inflation by its over-dependence on services, there’s a strong argument that a 25 per cent headline rate – accompanied by reliefs – would spur investment in capital-intensive activities such as manufacturing or research and development. “It’s a counterintuitive result, but to encourage investment, you need relief. Because the higher the tax rate, the more important the reliefs are.”

The counter-argument is that a higher headline rate deters foreign direct investment, but there is no business sufficiently careless that it will base its headquarters in the UK just because of a single, mostly performative number. In fact businesses are more likely to be attracted by the things tax buys, such as good infrastructure and skilled workers. The headline rate might look useful politically because “we’re slashing the big number” makes for a better headline than “we’re bringing in a long list of specific tax reliefs for different kinds of capital investment by companies”. But as recent events have shown, such headlines can backfire spectacularly.

[See also: Where is Liz Truss?]

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