Tax and Fiscal Policy

Hiking corporation tax: bad idea, worse timing


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Tax and Fiscal Policy
There is still plenty of speculation that the Treasury is thinking of raising UK corporation tax in the March Budget. The Financial Times has suggested that the Chancellor believes it would be fair to ask businesses for more after receiving taxpayer support during the pandemic. In my view, this would be a mistake.

For a start, there is no immediate need for tax rises of any kind. The UK economy has held up better than most had expected over the last few months and the early rollout of the Covid vaccines should accelerate the recovery this year.

In the meantime, the increase in debt is cheap and easy to finance, and the financial markets are hardly screaming for a return to any form of austerity. Increases in taxation – including corporate taxes – could therefore simply hold back this recovery.

At best, any money raised from higher corporate tax rates would also be little more than a rounding error in the context of extra borrowing which could be as much as £400 billion in total this year and next. The latest HMRC Ready Reckoners suggest that a one percentage point increase in the main rate of corporation tax might bring in an additional £2.4 billion in 2021-22, rising to (just) £3.4 billion in 2023-24. Frankly, what’s the point?

Even these figures are almost certainly an overestimate. They do take account of the ‘direct impact of a measure on the tax base to which it is being applied’. In the case of corporation tax, the HRMC does at least attempt to adjust for changes in the incentives for multinational companies to shift profits in and out of the UK, and for the reduced incentive to incorporate.

However, these adjustments are less reliable for larger increases in tax rates, where the behavioural responses are likely to be greater. In addition, the figures do not allow for the adverse effects on other tax bases, or on other economic factors, such as the impacts on inflation and investment.

More fundamentally, it is wrong to see business as an independent source of revenue which can simply be tapped at will. In reality, companies are only legal entities that exist to provide goods and services more efficiently than individuals working alone, and they cannot bear the economic burden of tax rises themselves. Put another way, all taxes are ultimately paid by actual people.

Some of the cost of higher corporate taxes may be borne by shareholders – including pensioners, who may or may not be relatively well-off. If you do want to target tax increases on these people it makes more sense to do so directly, via taxes on income or capital.

But most of the cost will be passed on to customers in the form of higher prices (one recent US study found that 31% of the burden of corporate tax falls on consumers) and to employees as lower wages (a review by the Adam Smith Institute suggests that at least 50% of the bill might land on workers in this way).

The argument that the UK should raise corporate taxes to repay Covid support is muddled too. What is this supposed to achieve? The companies that have benefited the most from this support (especially those saved from bankruptcy) will already start to pay more tax as they return to profit.

However, any increase in corporate tax rates would presumably raise the most revenue from businesses that have been able to thrive during the pandemic and were therefore least likely to have relied on government support. This would therefore be an extra tax on success. (A retrospective ‘windfall’ tax on ‘excess profits’ made during the pandemic itself would be even worse.)

Of course, there will be some who say that companies which have thrived as a result of the pandemic should be asked to pay a little bit more of their profits in tax. But even if you accept this in principle, how would you say which companies have benefited directly from Covid – and by how much? Do we really want to penalise companies which have responded so well to changing demands during an exceptional crisis (which, for the most part, is how they’ve made their additional profits)?

And if the government is going to raise corporate taxes ‘to pay for Covid’, should those businesses that have already voluntarily repaid some of the support from the taxpayer now ask for this money back again?

Last but not least, we need to think about the negative signals that raising corporation tax would now send. The government has already backtracked on one commitment here: the March 2020 Budget kept the main CT rate at 19% for the financial year beginning April 2020 (and set it at 19% for 2021-22 too), rather than cutting it (as had been promised) to 17%.

Some will argue that UK corporation tax is still relatively low at 19% and would remain so even if raised to (say) 22%. This much is true: according to the OECD database, the combined corporate income tax rate is about 28% in Italy, 30% in Germany, and 32% in France. But any increase in UK tax that closed these gaps would make the UK less competitive than it is now.

Just as importantly, the fact that many other countries have higher rates of what almost all economists agree is a bad tax is not a great reason for the UK to follow their lead. As Napoleon might have said, ‘never interrupt your competitors when they are making a mistake’.

The timing couldn’t be much worse either. Any increase in corporation tax might be the final straw for some global businesses who have to decide whether to invest in the UK after Brexit and are already worried by the current disruption at the borders.

Indeed, the global trend for many years has been for lower corporate tax rates. Despite this (or perhaps because of it) a 2019 OECD study found that the average share of corporate tax in total revenues has risen from 12% in 2000 to 13.3% in 2016, and from 2.7% to 3.0% as a share of GDP.

There are, to be fair, other factors at play here (in particular, the labour share of income has also fallen in many countries, so you might expect a bigger proportion of revenues to come from corporate taxes). Nonetheless, anyone arguing the UK should buck the trend and hike corporate taxes has an uphill task to show that this could actually raise a meaningful amount of money. Recommitting to the earlier plan to cut corporate tax rates would be a much better idea.

 

Julian Jessop is an independent economist with over thirty years of experience gained in the public sector, City and consultancy, including senior positions at HM Treasury, HSBC, Standard Chartered Bank and Capital Economics. He was Chief Economist and Head of the Brexit Unit at the IEA until December 2018 and continues to support our work, especially schools outreach, on a pro bono basis.


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