Anthony Browne MP is a member of the Treasury Select Committee and former CEO of the British Bankers’ Association.
There is a change of direction in the Budget that is causing murmurings on the low-tax side of the Conservative Party: the increase in Corporation Tax (CT).
A decade of sharp cuts to CT were justified by saying that they not only boosted investment and growth but also actually increased tax revenues. Ireland too is cited as an example, where the sleepy Celtic moggy cut CT rates to 12.5 per cent, the lowest in the industrial world, and was transformed into a Celtic tiger.
I too want low taxes, and this Laffer curve argument is appealing because it suggests that tax cuts can pay for themselves. But the Government is now planning a sharp rise in CT from 19 per cent to 25 per cent in 2023 for the most profitable firms, with the Budget Red Book showing the Treasury expects this to raise more than £17bn extra a year by 2025. But hang on! If lower CT rates increases revenue, then raising them can’t. Why the change?
So, in technical language, just what is the peak revenue-raising rate on the Laffer curve on Corporation Tax?
Laffer curves exist for all taxes, and their peak rates depend on many factors, such as the substitutability of the product, the elasticity of demand, mobility of production, the fungibility of capital and labour, and what other tax authorities are doing. Tax on sugary drinks probably has a very low Laffer curve peak because a small tax just prompts people to drink otherwise identical zero-sugar drinks. The Laffer curve on fuel is very high – well over 100 per cent – because people can’t do without fuel to drive.
On Corporation Tax, the Laffer curve would be lower for highly mobile sectors that can shop around for the lowest tax regimes in the world, and higher for ones that can’t easily move.
It is absolutely true that CT receipts have increased dramatically since George Osborne started cutting the rates, from £36.3bn in 2010-11 to £55.1bn in 2018-19. But that is largely because corporate profits were hugely depressed in 2010 in the wake of the deepest recession for a century. Corporation tax profits – and so CT revenues – are super-cyclical: exaggerated versions of the underlying economic cycle. Aggregate company profits on which CT is charged fell from £203.6bn in 2006/7 to £151.6bn in 2010/11, and then bounced back to £267bn in 2018/19.
After both the 1990/91 recession and the dotcom crash, CT revenues took just three years to return to their long run average as a percentage of GDP, but after the financial crisis, it took eight years, presumably because of the lower rates. Other changes have also increased CT revenues since the financial crisis including the corporation tax surcharge on banks (about £2bn a year), and widening the base of corporation tax. As it happens, CT revenues also rose sharply before the financial crash, and that had nothing to do with their rates because they were static throughout the entire period.
But CT is one source of tax revenue – what about the others?
Lower CT rates leads to lower cost of capital for companies, and so should increase investment and thus increase jobs, wages, GDP growth and consumption, leading to higher rates of income tax, VAT and so on. HM Treasury started doing dynamic modelling on the effects of cutting CT tax, to take into account the overall effects. In 2013, HMT and HMRC published a detailed analysis from the dynamic modelling, showing an increase in investment, in GDP (between 0.6 per cent and 0.8 per cent) and wages (£405-£515 per household). That lead to greater tax revenues, but only enough to reduce the loss of direct revenues by between 45 per cent and 60 per cent.
In other words, even a Treasury analysis, presumably designed to support Treasury policy, admits the CT cuts reduce overall tax revenues rather than increase them. It also surveyed the academic literature from around the world on this, and they all estimated that between 45 per cent and 90 per cent of the revenue loss would be made up – not enough of an impact to actually increase revenues.
There are other reasons to cut CT taxes than raising revenues. Another argument used is that cutting CT increases investment, but that also isn’t really supported by the evidence. Business investment is the same now when CT is 19 per cent as it was in the late 1990s, when CT was 30 per cent. Between 1997 and 2017, we had the lowest CT in the G7, but also the lowest average non-government investment at 14.3 per cent of GDP (compared to G7 average of 17.3 per cent).
Whatever the impact of low corporation tax in Ireland, it is really not comparable to the UK. When it introduced them, it was a much more agrarian economy with little inward investment and a major exporter of skilled people. There was not a big corporate base, and so it had little to lose from cutting CT.
If you want to use tax policy to increase investment, then it is better to target the tax cuts directly at investment decisions, as the Budget is doing with its “superdeduction” on investment, which will mean the Government will write off 25 per cent of any investment any business makes against its tax bill. Here is a suggestion for the corporate world: cutting corporation tax has not lead to a surge in investment, and it is now it is going back up. If you want to keep the “superdeduction” investment relief and make it permanent, prove to the Treasury that it works.