The UK government should still be cutting corporation tax, not raising it

Corporation tax hikes are apparently back on the agenda for the March Budget, with the Financial Times suggesting that the Chancellor believes it would be fair to ask businesses for more after taxpayer support during pandemic. This argument might score a few points with focus groups and play well on social media, but it is still poor economics.

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 help a strong recovery from the third nationwide lockdown. This in turn will do far more good for the public finances than any fiddling with tax rates.

In particular, government borrowing will fall sharply as the economy rebounds. 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 the 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 in April might bring in an additional £2.0 billion in 2021-22, £3.0 billion in 2022-23, rising to (just) £3.2 billion in 2023-24. Frankly, what’s the point?

What’s more, even these figures are almost certainly an overestimate. They do try to 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. But these adjustments are less reliable for larger increases in tax rates, where the behavioural responses are likely to be greater. (So you can’t necessarily just multiply the figure for a 1pp increase by three to arrive at an estimate of the additional revenue from a 3pp increase.) 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, rather than cutting it (as had been promised) to 17%.

It’s worth noting too that the March 2020 Budget also set the main rate at 19% for the coming financial year beginning April 2021. Raising that rate would therefore break another commitment. Perhaps this could be justified by the exceptional circumstances, but it’s hardly a good look, and the about-turn would add to business uncertainty.

Some will argue that UK corporation tax is still relatively low at 19% and would remain so even if raised to (say) 22% (which might raise £10 billion annually, at least based on the HMRC numbers). 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. Reverting to the earlier plan to cut corporate taxes would be a much better idea.

PS. I’ve been asked about the impact of cuts in the main rate of CT from 28% in 2010-11 to 19% in 2017-18. Despite these cuts, OBR data show the amount raised by onshore CT has risen from about £36 billion in 2010-11 to £49 billion in 2019-20. However, that is not really evidence that lower tax rates boost revenues.

In part this is because we cannot be sure what would have happened if tax rates had not been cut (the ‘counterfactual’). The chances are that revenues would have risen anyway over this period, as the economy grew. It therefore makes more sense to look at onshore CT revenues as a share of GDP. This ratio has barely changed (though at least it has not fallen, as some might have feared).

But there are two further complications. One is that the effective rate of CT has actually risen, because of other policy changes that have restricted the use of tax reliefs and deductions. The other is that the growth in CT receipts may partly have come at the expense of income tax and NICs, as more people have decided to incorporate their businesses to take advantage of the lower CT rates.

The upshot is that, while I would love to say that the recent experience in the UK proves that lower tax rates lead to higher tax revenues, the evidence is actually inconclusive. The OBR itself continues to assume that tax receipts would be higher if the main rate of CT had not been cut.

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