Generally speaking, the more you tax something, the less of it you get. The Government’s plans to raise Corporation Tax and end relief on new plant and machinery will result in less business investment – and steep costs for households.
By my estimations, Treasury’s current plans to raise the corporate income tax rate to 25% and end a temporary 130% ‘super-deduction’ for new investment in qualifying plant and machinery would lower UK investment by nearly 8%, and reduce the size of the UK economy by more than 2%, compared to making the current rules permanent.
Perhaps more importantly, because the economic costs of corporate taxation are ultimately borne both by shareholders and workers, raising the rate to 25% would permanently lower average household wages by £2,500. This calculation is based on extensive analysis of the relationship between corporate taxes and wages, and primarily reflects the fact that a smaller UK productive capital stock would mean less plant and equipment per worker, and therefore lower productivity and lower wages. In addition, a higher domestic corporate tax rate raises the value of firms’ outside options in lower-tax, lower-cost jurisdictions, which would degrade workers’ bargaining power.
Proponents of raising business taxes often point to increased revenues. But here there is substantially less than meets the eye. By lowering the future productive potential of the UK economy – and as a result the future potential tax base – the macroeconomic effects of raising the Corporation Tax rate to 25% would alone offset 40% of the static revenue gain over a 10-year period, and as much as 90% over the long run.
In contrast, just maintaining the rate at 19% and allowing business to continue to deduct the cost of new investment in equipment at a lower rate of 100% would still raise UK investment by almost 5% and GDP by 1.3%, compared to if current plans are implemented. Lowering the rate further, to 15%, would raise average household wages by an additional £1,700.
Critics of corporate tax reform should look to the recent experience of the United States, where in 2017 we lowered the federal corporate tax rate from 35% to 21%, and allowed businesses to deduct 100% of the cost of new equipment investment. At the time, I predicted that these changes would raise business investment in new plant and equipment by 9%, and raise average household earnings by $4,000 in real, inflation-adjusted terms.
Though business investment in the United States had been slowing in the years leading up to 2017, after the 2017 tax reform it surged, defying critics. By the end of 2019, investment had risen to 9.4% above its pre-2017 level. Investment by corporate businesses specifically was up even more, rising to 14.2% above its pre-2017 trend in real, inflation-adjusted terms. Meanwhile, in 2018 and 2019 real median household income in the United States rose by $5,000 – a bigger increase in just two years than in the entire 20 preceding years combined. In 2019 alone, real median household income rose by $4,400.
What about corporate income tax revenues? As in the United Kingdom, corporate taxes already constituted a smaller share of government tax revenue than in the United States on the eve of the 2017 tax cuts. Yet in 2021, even though the US economy was only slightly larger than the nonpartisan Congressional Budget Office had predicted in the wake of the 2017 tax changes, corporate tax revenue as a share of the US economy was substantially higher than projected, at 1.7% versus 1.4%. In other words, corporate tax revenue didn’t fall off a cliff after 2017.
Economic policymaking is about tradeoffs. In this case, the tradeoff is between a UK economy that is bigger, more productive, and paying higher wages, and a modest near-term revenue gain that diminishes substantially over time as lower growth reduces the corporate and personal income tax base. Considering the recent US experience and my own estimates of the effects of business taxation in the UK, I think it’s a no-brainer.
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