Is cutting Corporation Tax good for growth?

Everybody agrees that the UK economy needs more growth, like pretty much every other developed economy.  On the right it seems to be taken for granted that cutting corporate taxes will help.  This view deserves to be challenged.

An example of the argument for lower tax rates is this one from Tim Knox on the LSE website, promoted by the conservative think tank CPS.  Mr Knox suggests cutting the main rate from 28% to 20%, while simplifying a lot of the deductions.  The logic is simple.  The economy needs businesses to invest and expand.  A high corporate rate of tax is a disincentive to do so; a cut in rates would give businesses a shot of confidence that would get them moving.

This line of reasoning is not nonsense – and his ideas for simplifying the system on capital allowances and capital gains may make sense, though would be fiercely contested by lobbyists.  There is a lot nonsense talked about corporate taxes.  Companies aren’t people, and the payments companies make to people are taxed as employment or investment income.  There is quite a cogent argument (a classic essay topic for undergraduate economics students) that companies shouldn’t be taxed at all – though this would certainly open up opportunities for tax avoidance.

But a different way of looking at the predicament of the UK economy comes from Martin Wolf in the FT (paywall, I’m afraid).  He points out that one of the macroeconomic problems with the UK economy is the large value of the corporate surplus – in other words businesses are making too much profit and not spending enough.  He agrees with Andrew Smithers of Smithers and Co who published  a report entitled “UK: Narrower Profit Margins and Weaker Sterling Needed”.  Mr Wolf does not advocate raising corporate taxes, but he nevertheless poses an awkward question for those who advocate a cut.  The basic macroeconomic problem for the UK is that the government deficit is too high and its mirror image is a corporate surplus that is also too high.  Going back to Year 1 Economics, you can’t cut one without cutting the other (not entirely true, but the alternatives involve private individuals getting even more indebted, or an unrealistic export surplus).  How on earth does cutting corporate taxes help, without using voodoo concepts like the Laffer Curve?

In fact economically corporate tax is one of the more efficient ones in microeconomic terms – it does not distort incentives as much most other taxes, because it is based on profits, not inputs or outputs.  It amounts to a tax on capital – but capital is already having it very easy in the world economy, one of the drivers of increased inequality within nations (as opposed to between them…).

Strategically we should be thinking of more ways of taxing companies, on the basis of “use it or lose it” – it isn’t healthy for companies to sit on surplus profits.  A logical way would be to raise the tax rate but make dividends deductible – but this is probably a nightmare in practice.  Another idea is to cut the tax relief for debt interest – which would help restore the balance between debt and equity funding.  In the long term this would no doubt be very healthy and discourage companies from becoming over-indebted; in the short run it would be a bit like bayoneting the wounded after the battle, so implementation would need a great deal of care.

But even if either of these ideas look impractical, the argument for cutting the tax rate looks distinctly weak.

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