25 February 2021

Sunak should think twice about any rise in corporation tax

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It’s that time of year again, the air is thick with the flip-flapping of pre-Budget kite-flying.

Today’s instalment is a report in the FT suggesting that Rishi Sunak is planning to raise corporation tax to 25% over the course of the Parliament as he tries to claw back some of the last year’s spending splurge.

This isn’t a one-off, of course. We’ve had months of briefings about the Chancellor’s intention to hike the rate, which currently sits at 19%. – how things have changed since 2016 when George Osborne was talking about cutting the rate to 15% to create a “super-competitive” economy.

Now, it’s quite possible the 25% figure is, as one Tory quoted in the piece suggests, a “straw man”. It’s not exactly unheard of for politicians to float a difficult policy, only to then water it down, much to the relief of colleagues and commentators.

But even then, there are strong arguments against even a modest rise: some are general, others more specific to our current circumstances.

The most basic point is that corporate income taxes don’t simply fall on some nebulous entity called ‘a corporation’. In reality the prospects of businesses, employees and shoppers are indissoluble – tax one too heavily and the others inevitably suffer. This is borne out by OECD research suggesting such taxes are among the most damaging when it comes to GDP per capita. Just to hammer home this point, another paper from Oxford University’s Centre for Business Taxation looked at data from 55,000 companies across Europe and found that 49p of every £1 increase in corporation tax ultimately falls on employees.

But, given the UK’s corporation tax rate is relatively low compared to other Western countries, wouldn’t a rise simply be redressing the balance by taking a ‘fair share’ from under-taxed companies?  That might be the case if corporation tax were the only metric for how the taxman treats businesses. As my CPS colleague Tom Clougherty notes in a recent briefing paper:

“We might have one of the lowest headline tax rates, but tax is about more than just headline rates. Taking a more holistic view, the Tax Foundation in the US suggests that the UK’s corporate tax system is only the 17th most competitive in the OECD – and that when it comes to our tax treatment of corporate investment, we rank close to last.”

Put simply, for all the fuss about headline rates, Britain is not actually that competitive compared to other advanced economies and we should be extremely wary of any policy measures that send us further down the league table, especially now we’ve left the EU.

But let’s say you’re unswayed by those arguments and you really want to hike corporation tax. Would now really be the time to do so? Economists of all stripes seem almost unanimous that raising taxes on business after the year we’ve just had would be the wrong thing to do, and it’s striking that even Labour are saying quite firmly that there should be no new taxes on business at the Budget (whether anyone’s listening to them is another matter, admittedly).

It’s not just about the signals that hiking taxes now would send, or the fact that we can continue to fund spending through ultra-cheap borrowing. Even on a bald revenue calculation, now would be a very inopportune time to start raising corporate taxes, because –as Tom notes in his briefing – a lot of businesses are on their knees and will have big pandemic-induced losses to write off.  That means raising corporation tax now is unlikely to produce much revenue in the short-term. Should Sunak postpone the rise for another year that might produce more revenue, but it would also send an extremely off-putting signal to would-be investors.

So what should he do instead?

Although it’s always tempting for Chancellors to produce a flurry of measures at the Budget, given the roadmap the PM has just announced for lifting Covid restrictions, there’s a reasonable case for this being something of a ‘wait and see’ fiscal event. Indeed, a year of heavy government intervention in the economy only strengthens the case for taking the foot off a bit. (An excellent paper this week from my colleague Jethro Elsden showed convincingly that the best way to recover from wartime-type economic damage is to free up the private sector, not double-down on tax-and-spend.)

Given the savings many households have managed to build up over the last year, there’s every chance of a big summer rebound led by household spending and private sector investment. For both the short-term balance sheet and the long-term prospects for our economy, the Chancellor should think twice before introducing any measures that risk choking off that recovery.

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John Ashmore is Editor of CapX.