Economists have labelled George Osborne’s crusade to slash the UK’s corporation tax rate in the wake of the traumatic Brexit vote a “mistake”, the “wrong thing” and likely to “backfire”.
The Chancellor said last week he wants to push the levy on company profits down below 15 per cent in order to demonstrate that Britain is “open for business” to international investment in the wake of the shock vote by the electorate to leave the European Union.
Mr Osborne has already slashed the rate from 28 per cent in 2010 to 20 per cent today and has made deep reductions in the levy one of the centrepieces of his personal economic record.
The renewed drive from Mr Osborne to reduce the tax on company’s reported profits has been welcomed by libertarian think tanks such as the Adam Smith Institute and the Taxpayers' Alliance, but a host of senior economists interviewed by The Independent have questioned the Chancellor’s proposed direction of travel.
“I think there is this kind of confusion between wanting a competitive economy and saying the way we get it is reducing the rate of corporation tax. I think that is just a mistake” said John Van Reenen of the London School of Economics’ Centre for Economic Performance.
“The way you get a productive economy is changing the fundamentals. You get your people to be more skilled, or you have your infrastructure working efficiently. You’re never really going to get there just by reducing corporate tax.”
The Treasury published an economic model in 2013 which suggested reducing the corporation tax rate reduces the “cost of capital” of businesses and thus tends to increase their levels of investment. This increase in company investment feeds directly into higher GDP.
The economic model used by the independent Office for Budget Responsibility also assumes cuts in corporation tax increase business investment by around 0.3-0.5 per cent over its forecast horizon for each percentage point reduction in the rate.
Impact of corporation tax cuts on investment
However, the Treasury’s model does not assume the increase in GDP and boost to tax revenues is large enough that rate cuts end up “paying for themselves”.
And the Institute for Fiscal Studies estimates that the Chancellor’s corporation tax cuts over the past six years mean tax revenues are now lower by around £10.8bn a year (in 2015-16 terms) than they otherwise would have been.
“There are lots of spending decisions for which this money could be utilised” said Simon Kirby, head of economic modelling at the National Institute of Economic and Social Research.
“[They say] this has long-run positive growth implications because we get more investment. But lots of things have long-run positive growth implications, be they investment in infrastructure, investment in education and training and so on. And that’s what you should be comparing it to.”
Professor Michael Devereux, the director of the Oxford University’s Centre for Business Taxation, said the thrust of the Chancellor’s rate reduction strategy was misguided and would be likely to exacerbate a zero-sum international race to the bottom between governments on tax rates.
“We’re focusing on the wrong thing. What I’d recommend is a complete overhaul of the corporation tax system. Try and tax profits in the place where the sales are made. That ties in with the popular mood. If we moved to a tax based on sales then the tax rate ceases to be important and the competitive pressure gets taken away” he said.
Corporation tax bought in £45bn in 2015, according to the Office for National Statistics, up from around £42bn when Mr Osborne became Chancellor.
But as a share of GDP the corporation tax take has declined in step with the Chancellor's headline rate cuts falling from 2.8 per cent in 2010 to 2.3 per cent last year.
Tax rate down, tax take down
The head of the World Trade Organisation, Pascal Lamy, and a host of charities have already criticised Mr Osborne’s latest drive as dangerous “tax competition”, which reduces corporate tax revenues everywhere in the world, including in developing countries.
The UK already has one of the lowest headline rates of corporation tax in the G20 and further cuts would put the UK in the same bracket as states like Ireland, which has a 12.5 per cent rate and Latvia (15 per cent).
Allan Monks, an economist at JP Morgan, added cuts to the British rate could hamper the UK’s efforts to negotiate a favourable post-Brexit trade deal with the rest of the EU.
“Any suggestion that the UK is moving toward setting itself up as semi tax-haven is going to antagonise the rest of the EU even before discussions on our terms of exit begin” he said.
The Chancellor has implied that further deep cuts in the corporation tax rate, which was already flagged to come down to 17 per cent by 2020, might provide a near-term stimulus to the UK economy by encouraging business investment as it teeters on the brink of recession.
But Christian Odendahl and John Springford of the Centre for European Reform said this was likely to “backfire”.
“The stimulative effect of such tax cuts in the short run is weak, as with monetary policy. Companies will be unlikely to invest their extra earnings while they face uncertainty" they said.
"And the more the UK plans to become a tax haven the tougher the EU will be as a negotiating partner. The remaining states have no interest in rewarding the UK for attracting investors by undercutting tax rates elsewhere in Europe."
Larry Summers, the former US Treasury Secretary, writing in the Financial Times, has suggested that previous corporation tax rate reductions by the UK and other nations, seen as an element of an elite-focused policy agenda, had been partly behind the rise of popular disaffection with established political parties, which helped deliver the Brexit vote.
“Tax burdens on workers around the world are a trillion dollars or more greater than they would be if we had a proper system of international co-ordination that identified capital income and prevented a race to the bottom in its taxation” he wrote.
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