Corporate tax hike is a risk Chancellor may regret – Institute For Fiscal Studies
IIt is far behind the big three – income tax, national insurance and VAT – but Corporation tax comes as our fourth source of income. It grossed a pretty handy £60bn in 2019-20, just before the pandemic hit. As a fraction of national income, it has grown the most this century, slightly more even than its pre-financial crisis peak when the economy was running at full steam and the overall tax rate was much higher. higher than it is today.
The decision to increase the main rate by six percentage points in the budget was therefore important. It was also a surprise, and a remarkable U-turn. For a decade, Tory chancellors prioritized reducing the corporate tax rate from 26% to 19%. In fact, assuming that happens, it will be the first headline rate increase since 1974, when Denis Healey was Chancellor, Harold Wilson was Prime Minister and we had yet to hold our first Common Market membership referendum. .
Aimed to raise an additional £17bn a year, this is a big change indeed. So what to do?
The Chancellor reassured us that even after this increase, the UK’s corporate tax rate would remain the lowest in the group of G7 nations. About true of the headline rate if you factor in US state level taxes. This is not really true if you look at what matters, i.e. the effective rate, i.e. the rate that is actually paid either on average or on the return on the investment marginal.
It’s already in the middle of the pack internationally rather than particularly low, because we have a fairly broad tax base. A greater proportion of company income earned in the UK is actually taxed than in many other countries.
This is one of the reasons why UK corporation tax revenues are already higher than some other G7 countries and, like effective tax rates, average rather than low compared to international standards. This is also part of the reason why the steady decline in the tax rate has not led to a steady reduction in tax revenue. Revenues in 2019 were above the average of the previous 40 years despite a much lower overall rate. They had been climbing since 2010. This does not prove that cutting rates generates more revenue. The tax base has widened further in recent years and, of course, revenues were expected to rise from their post-financial crisis cyclical low.
Given the fashion of predicting the disappearance of corporation tax in the face of globalization, the advance of advanced technologies and increasingly sophisticated financial engineering, the robustness of corporate tax revenues companies took many, myself included, by surprise. We are still able to extract significant sums from large companies.
Just as I do not believe that the decline in the rate after 2010 was responsible for the increase in income, I also do not believe that an increase will lead to a decrease in income. However, this is unlikely to lead to the extra £17billion a year the Chancellor is counting on, at least in the longer term. Higher rates have effects on investment decisions and not all of these effects are captured by official estimates.
There are certainly risks involved in such a steep rise. Professor Michael Devereux of the University of Oxford’s Center for Business Taxation estimates the proposed increase could reduce foreign direct investment by 5% from 2023, with a significantly larger negative effect on overall investment. If this happens, it will hurt productivity and the UK’s standard of living. Both will have already suffered from the appallingly low investment levels of recent years.
Bear in mind that the effect on living standards will be on top of the direct tax take of £17billion, or whatever. That’s £17 billion that will, one way or another, come from customers, employees or shareholders of the businesses affected. One of the things that makes a corporate tax hike politically attractive is the fact that it’s not at all clear who will foot the bill. Don’t worry, someone will.
But all this pain is for the future. The rate increase is not expected to come into effect until April 2023. In the next two years, another very important change will be made to corporation tax: the introduction of a “super-deduction”, allowing companies to deduct 130 per cent of the cost of investment in plant and machinery from taxable profits. Costing more than £25billion over two years, it aims to advance, and hopefully stimulate, investment to support the economy as it emerges from the pandemic. It represents a significant subsidy to large investments during this two-year period.
In fact, it is also simply necessary to avoid discouraging small investments, up to the normal annual investment premium. Without this additional deduction, it would otherwise be better to wait until 2023 to deduct the investment from the higher tax rate of 25%. Announcement of future rate hikes can have undesirable short-term effects.
It’s pretty easy to see the politics behind Rishi Sunak’s choice tax hike. Opaque in the future, jam today, well-hidden pain tomorrow. The magnitude of the increase, however, makes the economy more concerning. Not only is he unlikely to get as much income as he hopes, but he risks reducing investment levels and therefore wages and living standards in the long run.
He may also want to consider how difficult it is to untie supposedly temporary gifts as he prepares to get rid of his hugely expensive super-deduction in two years.
This article first appeared in The Times and is reproduced here with kind permission.