After Nigel Lawson’s great tax reforming budget in 1984, which cut the headline rate of corporation tax from 52% to 35%, I visited the then IBM Head of Tax Worldwide in Armonk, New York in my role as the IBM UK Chief Economist. I asked him if he was aware of the change, which he was, and what he thought about it. I had expected him to be disappointed, since the previous system, with a higher tax rate but generous 100% capital allowances, was favourable to investment in computers. But he wasn’t. He was much more impressed by the reduction in the tax rate than unimpressed by the reduction in allowances. And he assured me that international investors always look at the headline rate first and treat allowances as a secondary issue.
So I suspect that if it is true that the Chancellor plans to raise the rate of corporate tax in his March 3 budget, he may be surprised how little revenue he gains.
Corporate taxes are one of the areas where the economists claim that they’ve proved that something that works in practice doesn’t work in theory often rings true.
In fact the UK has developed a tax regime where we get quite a lot of revenue while appearing to outside investors to have quite a low tax rate. The latest OECD stats (for 2018) show that the UK gets 8.0% of its tax revenue from corporate taxes with a headline rate of 19% (2018) compared with 4.6% in France and 5.6% in Germany, with headline rates of 33% and 30%. The highest shares in Europe are Ireland with 14.2% (headline tax rate 12.5% in 2018) and Luxembourg 15.9% with a headline rate of 26% but deductibility for interest and dividends and where most large companies have individual tax deals with the government.
In theory a system of raising corporate taxes and increasing investment allowances should raise more revenue while encouraging more investment. But I would be surprised if either of these happened in real life.
First, higher investment allowances mainly mean that you in effect depreciate your investment quicker and you normally get the same tax relief in the end. Second, corporate income that is distributed in dividends gets taxed eventually at the income tax rate anyway, so for distributed income, there are no revenue gains from a higher corporate tax rate.
The international comparisons show higher corporate tax revenue for lower rates. So why do highly skilled tax economists believe the opposite? I suspect the reason why is that they model countries individually and model behavioural reaction to tax changes in too much detail. Because of all the moving parts, it is always difficult to get econometric estimates to come out quite as they should and they often show smaller behavioural changes than real life experience would lead one to expect. The second is that they probably don’t fully allow for the extent to which corporates in practice have a degree of discretion about where they book their profits. There is enough scope for flexibility in a range of items from transfer pricing to writing off intellectual property to give multinationals scope. They normally book their profits in the lower marginal tax regimes.
So, if Rushi Sunak does raise corporation tax in the budget he might even find he gets less rather than more revenue.
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