Why cutting Corporation Tax won’t help the British economy


8:48 am - March 19th 2012

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contribution by Nicholas Shaxson and John Christensen

As Budget Day approaches the UK Chancellor is vowing to press ahead with cuts in the UK corporate tax rate and to create new loopholes for corporations using offshore tax havens.

The 2010 budget announced four annual drops in the main rate of corporation tax from 28 percent in 2010 to 24 percent in 2014, with the stated aim of making Britain more ‘competitive’.

But this strategy to chisel away at corporate tax revenues is founded on elementary misunderstandings about Britain’s plight.

Here is the first problem. British corporations are sitting on oceans of cash: a stunning £750 billion or so at the last count, and growing fast. (In the Eurozone and the U.S., the figures are about €2 trillion and $1.7 trillion respectively.)

Corporation tax cuts, then, take money from a sector (government) that puts it straight to use – building roads and schools, running universities, keeping the courts open, and so on – and handing it to a sector (corporations) that lets it sit idle. This is exactly the wrong thing to do.

Cuts are the wrong medicine, whether you think Britain needs stimulus or austerity.

Second: if you like stimulus, then cutting corporation tax is the worst way to get it. The U.S. Congressional Budget Office concluded fairly recently that corporate tax cuts (and tax cuts for high income earners) were the least effective of all the options for stimulating economic activity. Far better to stimulate in cleverer ways, such as by investing more or by lowering taxes only on firms that do invest while preserving or raising taxes on those that don’t.

If you favour austerity, then corporate tax cuts boost the deficit directly. All the evidence of the last few decades suggests that tax cuts do not pay for themselves, as some people claim. The purpose of austerity is not to inflict pain but to cut the public debt; since corporate tax cuts are so ineffective in stimulating economic activity, the result will be more pain and more debt: the worst of all worlds.

Third: This is not just a short term issue either. For most corporations deciding where to invest, tax rates are usually fairly low on their agenda, beneath things like a productive and healthy workforce, access to markets and good infrastructure, and political stability.

Would you site a car plant in Somalia if it offered a juicy tax break? Tax-cutters might also like to explain why real investment and economic growth were so much higher during the quarter century after the Second World War, when tax rates were much higher than today.

The corporations most sensitive to tax rates are the most mobile ones – which mainly means financial firms. So corporate tax cuts may boost profits in the City of London, but without stimulating activity elsewhere. If you want to rebalance Britain’s economy then this is, again, precisely the wrong direction to take.

Finally, what does it mean for Britain to be ‘competitive?’ Many people lazily conflate competition between firms in a market with competition between jurisdictions on tax. But these are two wholly different economic beasts.

Think about it like this: if a firm cannot compete it goes bust, and despite all the pain involved this ‘creative destruction’ can be a source of economic dynamism. But what do you get if a country cannot ‘compete?’ A failed state? Greece? Tax ‘competition’ is a far less savoury creature, and when politicians talk of a ‘competitive’ tax system – don’t fall for it. Corporate tax cutting will damage Britain’s economic health, and what is ‘competitive’ about that?

If Britain wants a balanced and competitive economy it will put money into the hands of those who will use it, instead of whittling down precious taxes on the basis of ideology, woolly economic thinking and effective carte blanche to large corporations to write the some of the UK’s tax laws.

—–
Nicholas Shaxson is author of Treasure Islands: tax havens and the men who stole the world. John Christensen is director of the Tax Justice Network.

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Reader comments


So you are proposing corporation tax rises. What level do you propose, and how will that help the economy? It’s all very well being against something, but when you talk about it being “precisely the wrong direction to take”, wouldn’t it help to propose an alternative and explain why it is better.

Note that a corporation is a nebulous entity made up of people. There is a lot of evidence that corporation and other employment taxes are very good at holding wages down (ratios of greater than 1.0) , which is probably what owners of large companies want to increase their profits. Wouldn’t reducing the tax take go to the workers?

Reader JC: re the level of corporation taxes, first of all, how about engaging with the actual argument? Second, this article explicitly doesn’t propose a tax rate, just explains why corporate tax cuts are quack medicine. If you accept the article’s premise, feel free to propose a rate. If you don’t accept it, then please explain why it’s wrong. Second, the ‘corporation is a nebulous entity made up of people’ is a tired and weary argument, and wrong. First, a corporation is a legal person in its own right. The courts have said so. Second, how come when there’s a surprise tax story, corporations’ share prices take a hit? (Here’s a good example: http://bit.ly/wCoFeS ) If it was workers who took the hit, then shareholders wouldn’t. Third, why do corporate directors spend so much time on tax avoidance, if they could simply lay all those taxes off onto workers? They surely aren’t doing it out of pure concern for their workers’ welfare. And a bunch of other arguments here. http://bit.ly/Au7Oii

@ JC

“It’s all very well being against something, but when you talk about it being “precisely the wrong direction to take”, wouldn’t it help to propose an alternative and explain why it is better.”

I think the author is deliberately leaving two alternatives open, to demonstrate that cutting corporation tax is the wrong thing to do whichever side of the stimulus/austerity debate you come down on.

If you favour stimulus, alternatives would include better targeted tax cuts (e.g. tax cuts for businesses investing in R&D, taking on apprentices, or paying a Living Wage; cuts to VAT), and/or targeted spending (e.g. tax credits to keep people in work & spending on the high street, investment in infrastructure, job creation programmes).

If you favour austerity, the alternative is simply *not* to cut taxes, or even to raise taxes, in order to maximise revenues and eliminate the deficit more quickly.

4. Luis Enrique

I don’t know what to think on this issue.

I find it hard to believe lower corp taxes will help much. Superficially at least, in recent decades corp taxes have fallen, but investment rates have too, and inequality has risen (helped by bumper corporate profits and dividend income for the 1%) – although we don’t know what would have happened if corp rates had been higher, maybe low investment rates and high inequality have other explanations.

however, most theory says corp taxes isn’t a great idea

Here is the Mirrless report chapter “Taxing Corporate Profits”

http://www.ifs.org.uk/mirrleesreview/design/ch17.pdf

and empirical evidence tends to find negative effects too

http://www.mathematik.uni-ulm.de/wipo/lehre/ws200708/public_economics/Kneller_Bleaney_Gemmell.pdf

but on this issue maybe I depart from the econ mainstream

Note that a corporation is a nebulous entity made up of people. There is a lot of evidence that corporation and other employment taxes are very good at holding wages down (ratios of greater than 1.0) ,

No there isn’t.

Plenty of evidence the other way though – that the rush to cut corporation tax has not only led to a weakening of the tax base, but has led to lower share of wages as % of GDP too.

. What level do you propose, and how will that help the economy?

Main rate back to 30pc. Will help economy as per point 1 above.

6. Steven Hogg

This article is spot on – to fund these Tax Cuts for big business, the Chancellor has reduced the tax relief on investing in new plant and equipment, hitting many small businesses and affecting even large ones. Put simply, a UK large company will be able to make less money before tax but has the same left after tax – in other words, the taxpayer takes the hit. It will do nothing to encourage the economy – to gain the benefit, all a Company needs to do is make more than £300,000 per annum – if it already does this, it needs do nothing more. Yet the Corporation Tax rate remains twice that of Eire, so any business acting as a “tax-rate tart” will still head for Dublin, not the UK!

Just another Tory policy to help its sponsors in big business – and banks and other financial instituations are likely to benefit most.

The main funding for this has, of course, come from the VAT rate rise, which has damaged the economy.

I think this article tends to make sweeping generalisations that may not hold in all cases.

” If you favour austerity, then corporate tax cuts boost the deficit directly. ”

It depends whether corporation tax reductions raise the level of investment.

” Here is the first problem. British corporations are sitting on oceans of cash: a stunning £750 billion or so at the last count, and growing fast. (In the Eurozone and the U.S., the figures are about €2 trillion and $1.7 trillion respectively.) ”

Here is the problem for which you provide no insight. Why?

Firms make money by generating a positive return on capital invested. They are not sitting on large cash balances to be mean to the economy. Generally, cash sitting idly on balance sheets is an inefficient use of capital. A bad sign over the last two years has been firms using cash balances for share buybacks and returning the money to shareholders. What they are effectively saying is investors are as well getting this money back because we can’t find any profitable way to use the capital. Not good.

When a firm is looking to invest capital they must consider the return that capital will make. If the anticipated return is not positive taking into account the risks then they will not invest. We get stagnation. The firm may well be currently highly profitable. However, the issue is whether any additional capital can generate a return on capital invested. That is why we get profitable firms who are cutting back on investment and simultaneously sitting with large cash balance sheets. The liquidity does eventually end up with the government through flowing into the government bond market. That is why I’ve been saying for over two years (before everyone else) that it will be a positive sign when we get a sell off in the gilts market. More profitable uses for capital will have become available.

Another consideration why some firms are sitting with huge cash balances is precautionary. In 2008, we seen the biggest liquidity squeeze of all time. The commercial paper market that large firms use to fund themselves stopped working. Financially sound huge global names were even struggling to raise the liquidity to operate the firm. Smaller firms have seen what happens if the banking system stops working. All these things are fresh in the memories of finance directors and treasuries. Therefore, they are being ultra cautious by holding large cash reserves.

Now, basic arithmetic tells us that lowering the tax rate on end profits must at the same time change the calculations on the capital invested to generate that profit. Therefore, reducing corporation tax will increase investment.

” Tax-cutters might also like to explain why real investment and economic growth were so much higher during the quarter century after the Second World War, when tax rates were much higher than today. ”

Well you do not say where investment was higher. Everywhere on the planet? Did Thailand have higher investment then compared to now? Again, we come back to what return the investment of capital can make where it is employed. You would need to provide some sort of analysis of returns for the comparison of these periods to be meaningful. Just saying corporate tax rates were higher after the Second World War and so was investment is of itself meaningless. The return on capital invested and not tax rates is what you want to look at.

” But what do you get if a country cannot ‘compete?’ ”

You get a fallacy. Firms compete and workers within a country compete with each other. However, a country does not compete, it is just shorthand for saying other things.

Just another example of how the politicians are just puppets of the corporate elites. Corporate tax rates in the US are at 60 year lows, and yet the mantra of “tax cuts solves everything” continues. The loop holes are so large that many corporations pay not a penny in tax.

Yet these scroungers are first in line demanding bail outs and hand outs. And the less tax they pay the more money they have to fund political campaigns demanding ever more control over our lives. The gap between rich and poor keeps growing, and real wage increases for most workers are going backwards. This really is the new gilded age. Sharpen your guillotines, you are going to need them.

Richard W., thanks for engaging on the substance of the arguments, and your points are worth responding to. In short, you asked questions which I’d have answered if I’d had space. I had more space here – http://treasureislands.org/lse-cutting-uk-corporate-taxes-right-now-is-insane/ and you will find some of the answers here.
1. It depends on whether tax cuts boost investment. The longer blog addresses that. The aon and wpp examples are particularly brutal reminders of what’s going on: the firms that respond most to corporate tax cuts are mobile ones, and that typically means financial ones. Cut corporate taxes, and you boost the City while doing little for the real economy.
2. The reasons you give for firms not investing. I have no disagreement, and in fact on the precautionary aspect, Tony Barber had a useful article in the FT recently comparing this with Asian precautionary savings.
3. “basic arithmetic tells us that . . . reducing corporation tax will increase investment.” Well, yes, to be more precise, economic theory tells us that. Unfortunately, the facts on the ground tell us a different story, as my article explains. And that’s the reality of what Britain faces.
4. The Golden Age after WW2. It was widespread. In the U.S., in Europe, and also in many developing countries. I wrote quite a bit about it in the Keynes chapter of Treasure Islands.
5. But what do you get if a country cannot ‘compete? A fallacy. Exactly. Precisely. We are in full agreement. Politicians who say we can ‘compete’ better by cutting corporation taxes are dealing in quack medicine. It sounds good, but it is economic nonsense.

10. Luis Enrique

hang on – countries do compete. Multinational firms make production location decisions, so countries compete in that sense, they compete as a destination for skilled migrant workers, and I can’t see anything wrong with talking about countries compete in export markets (acceptable shorthand for firms within countries doing so)

10 – the change in UK patent laws is a perfect example.


Reactions: Twitter, blogs
  1. Liberal Conspiracy

    Why cutting Corporation Tax won't help the British economy http://t.co/eoQSCZVq

  2. Nicholas Ripley

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  3. Jason Brickley

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  4. Pyrmontvillage

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  5. Taxation

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  6. Phil Jones

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  7. Brad Marshall

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  11. Edward Clarke

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  15. Stuart Foster

    RT@libcon: Why cutting Corporation Tax won't help the British economy http://t.co/KOJblTva

  16. leftlinks

    Liberal Conspiracy – Why cutting Corporation Tax won’t help the British economy http://t.co/Mnif6s1W

  17. keith ferguson

    Liberal Conspiracy – Why cutting Corporation Tax won’t help the British economy http://t.co/Mnif6s1W

  18. Paul W

    RT @libcon: Why cutting Corporation Tax won't help the British economy
    http://t.co/uZhyHYzg

    "Wont help" is being extraordinarily generous!

  19. Alan Hinnrichs

    Why cutting #CorporationTax won’t help the British #economy | Liberal Conspiracy http://t.co/UYiRRlyc via @libcon

  20. Jordan Hall

    Cuts to corp tax & those on high earners least effective in stimulating econ. activity. Lack of consumer demand is prob http://t.co/kEPvTj1j

  21. Nicholas Shaxson

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/gwT9dvVI

  22. Alex Marshall

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/gwT9dvVI

  23. +GT÷

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/gwT9dvVI

  24. Cutting corporate taxes is quack medicine | Treasure Islands: Tax Havens and the men who stole the world | A book by Nicholas Shaxson

    […] now have an article, co-authored with John Christensen, on the Liberal Conspiracy blog, entitled Why Cutting Corporate Taxes Won’t Help the British Economy. This article was actually shortened from the version I sent them, so I hope they don’t mind […]

  25. Chris Jordan

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/nI7pkks5 via @libcon

  26. Andrew Robinson

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/zwQ0G6IW via @libcon

  27. Michael Smith

    Hope the #SNP are reading this>RT @nickshaxson Why cutting Corporation Tax won’t help the British economy http://t.co/YELIOOf6

  28. Sean

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/lh1jvz74 via @libcon

  29. Thomas Milman

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/2xpCYBS6 via @libcon by Nicholas Shaxton

  30. Marie J

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/gwT9dvVI

  31. Morgan Dalton

    Why cutting Corporation Tax won’t help the British economy | Liberal Conspiracy http://t.co/gwT9dvVI

  32. More on those quack UK corporation tax cuts | Treasure Islands: Tax Havens and the men who stole the world | A book by Nicholas Shaxson

    […] lies behind corporate tax-cutting. It followed my LSE blog, my longer Treasure Islands blog, and Liberal Conspiracy article, along the same lines. (As I’ve mentioned, this argument constitutes low-hanging fruit […]

  33. sunny hundal

    @ryancps @afneil Are you controlling for changes in other parts that make up GDP? Also, Corp tax cuts useless http://t.co/uEfx0AwG





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