Tim Knox is Director of the Centre for Policy Studies which today publishes How to cut Corporation Tax (pdf) by David Martin.

We have heard rather a lot recently about how we must not tolerate “high rewards for failure”. But there is a logical corollary to that particular line: that we should be equally vehement about not imposing high penalties on success. And that is what the tax system does, not just on those individuals who pay higher rate taxes but also on business. For Corporation Tax – a tax on business profits – is effectively a tax that is only paid by successful businesses. It is money taken by the state from highly productive enterprises, money that could otherwise have been reinvested in new ventures. And it is money that is then consumed by the state, notorious for its low level of productivity.

In this way, the state penalises the only organisations which can get us out of the hole that we are in. For growth will only come from business: the state and the consumer are both far too indebted. That is why, as leading tax expert David Martin argues in his Centre for Policy Studies paper published today, George Osborne should announce in his March Budget an immediate cut in the main rate of Corporation Tax from its current level of 26% to 20%. At the same time, he could also announce his intention to reduce it even further – to 15% or even 10% once the appropriate anti-avoidance measures are in place.

Such a move would have numerous benefits:

  • It would boost business confidence, encourage new investment by businesses (as it would improve net returns) and would send a strong signal that the Coalition is taking the bold supply-side measures necessary to restore growth.
  • It would immediately fulfil the Coalition pledge to “create the most competitive corporate tax regime in the G20”. Until 2005, UK rates of Corporation Tax were lower than the OECD average. Since then—despite the Coalition’s efforts so far – the UK has fallen behind.
  • It would present an opportunity for a major simplification of the tax system. If the tax base was defined as business profits, then we could sweep away the separate rules and calculations for different sources of income, and for capital gains, and for capital allowances; and abolish all the complex rules for aggregating the results of these calculations, and for how profits and losses can be offset.
  • It could have a significant “wealth effect”. One of the key measures of assessing the value of a company is the P/E multiple (the price earnings multiple). If earnings per share are enhanced because of a lower tax charge, the value of equities will tend to rise over time (assuming an unchanged P/E multiple). Higher share prices benefit most corporate pension funds (particularly through reducing the actuarial deficit), life assurance companies, other institutional investors and unit and investment trusts which harness the savings of millions of people. Private individuals thereby achieve a higher valuation of their equity investments through rising share prices which potentially enhance consumer confidence. That in turn adds to the buoyancy of the economy.
  • It could also heighten the impact of any further Quantitative Easing – or possibly even reduce the need for more QE. The use of QE by both the Bank of England and the Fed has tended to result in higher equity prices, thereby enhancing consumer confidence through this “wealth effect”, a consequence that has been publicly welcomed by both central banks. A reduction in Corporation Tax should achieve precisely the same effect. Moreover, that effect might well be leveraged by an announcement of an intention to reduce the rate further as it would result in an upward re-rating of P/E multiples caused by greater investor confidence in the regime of lower Corporate Tax rates.

All very well, some will say. But how on earth can we afford to do this at a time when the Government has such a huge deficit? A quick look at the graph below should reassure everyone that cutting the rate of Corporation Tax does not necessarily lead to a fall in the revenue it generates for the Treasury. Indeed, the main rate of Corporation Tax has fallen from 52% in 1982 to 26% today. This halving of the rate of Corporation Tax has been accompanied by an increase in the revenue it has generated for the Treasury: in 1982-83, it yielded revenues equivalent to 2.0% of GDP. In this financial year, the Treasury expects Corporation Tax to yield 2.8% of GDP (or £43.2 billion).

However, given the feeble state of the public finances, the static costs of a cut to 20% should be noted, not least to reassure the financial markets that the Coalition remains committed to its deficit reduction plan. Depending on the approach used, this might involve a loss of revenue to the Treasury of between £4 billion (according to the Treasury ready reckoner) and £8.5 billion (on a straight line basis). Those who insist on a static approach should also remember that cutting Corporation Tax rates at a time of relatively low corporate profitability (as is currently the case) is going to be cheaper than in more robust economic times. Finally, if it were thought absolutely necessary to fund this tax cut, this theoretical fall in revenue could easily be matched by the abolition of higher rate tax relief on pensions.

It is greatly to be hoped that the recent spate of “banker-bashing” will have dissipated by the time George Osborne announces his Budget on 21st March; and that the Coalition will feel confident and bold enough to make this substantial reform. The potential benefits – economic, fiscal and political – are huge; the downside is limited. So the right question is not: can we afford to do this? But: can we afford not to cut Corporation Tax to 20%?

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