14 October 2022

Of all the u-turns, a big hike in corporation tax rise is Truss’ worst option


At this point, it’s safe to say that Liz Truss’ mini-budget was not a political success. Pairing tax cuts with a massive and highly uncertain commitment to subsidising energy demand in the price cap left markets twitchy about increased domestic demand driving up inflation and interest rates, and a lack of detail on the growth-generating policies expected to pay for the long-term tax cuts made them downright nervous. Where markets spook, so do MPs, and the Conservative backbenches are now back in their default mode for the last six years (attempt to overthrow the leader, then wonder why all the talent is leaving the party).

Having introduced the 45p rate cut (then backtracked), insisted that no further detail on policy would be offered until November (then backtracked), and dabbled with the idea of benefits cuts (then backtracked), it’s not exactly surprising that Truss is now u-turning on her budget again. And given the way in which this has all been handled, it’s also unsurprising that the latest u-turn would be reversing the most economically significant tax cuts in favour of retaining the least.

Kwasi Kwarteng is flying back early from New York as expectations solidify around an increase in the rate of corporation tax. If you’ve not been keeping track of this particular rate, I can’t blame you: Sunak promised to increase it in April, Kwarteng announced it would be frozen in September, and now Truss looks set to increase it in October. This is, of course, the sort of stable and predictable environment in which business investment thrives.

The thing about corporation tax is that it is a bad tax. Raising money through it is worse for growth by a considerable margin than raising the same amount of money through income tax; in fact, in terms of people’s incomes, corporation tax is the most damaging option available. This might seem unintuitive, because in both cases the actual cost of the tax falls on people, whether on shareholders, workers, and customers in the first case, or directly on their tax statements in the second. But the tricky businesses with corporation tax is that it distorts incentives for investment, reducing productivity, and with it economic growth.

As the Centre for Policy Studies has noted, cancelling the corporation tax increase would have been likely to lift UK GDP up by 1.2%, investment by 2%, and wages by 1.1%. These are not numbers to be sniffed at. This doesn’t make corporation tax cuts self-funding, but does mean you spend rather less than you might think on cutting them. And it also makes them the cheapest tax cut for spurring economic growth – other than possibly the 45p rate cut, which might well have paid for itself in the end.

Remember also that the game of government isn’t just about maximising total revenue; there is a trade-off between money raised from taxes, and the size of the economy, and both things matter for the population’s well-being. But it is unfortunately also true that corporation tax cuts – and cuts to the higher rate – are highly unpopular for political and distributional reasons. The mini-budget was framed as an attempt to help households with the cost of living and a growth plan all in one. But when push comes to shove, the first part takes political priority.

In these circumstances, the easiest measures to reverse are those which do not directly impact most household’s pockets – even if they are the measures most relevant to increasing growth. Truss’ inability to implement her budget is cause for considerably more pessimism about the rest of her agenda. Pro-growth reforms are generally held up because there is opposition to them from vested interests – including the anti-growth coalition within her own party; planning reform or infrastructure construction are two of the most obvious examples. If Truss can’t persuade the Conservative Party to vote for tax cuts, then the probability of getting planning reform through is considerably lower than it was before.

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Sam Ashworth-Hayes is an economist and writer.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.