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This week saw a breakthrough in our country for the American economist Arthur Laffer and his eponymous curve.

The Treasury has produced some estimates on the “dynamic effects” of Corporation tax reductions. Hitherto this has been something of a Whitehall taboo. They have insisted in their projections that a tax rate increase will provide a proportionate increase in revenue, while a tax rate cut will mean a proportionate fall in revenue.

I understand that this week’s venture is just the start. We can expect that a similar approach will be developed to other taxes. Given that the Office of Budgetary Responsibility is an independent body whether they propose to take account of them is another matter. There is also the consideration that the gains in tax revenue from economic growth tend to over the middle to long term while the OBR tends to focus on the shorter term.

Anyway there is an interesting report from the TaxPayers Alliance out today which calls for the Government to go further.

The Government is commended by the Alliance for “following the example of a number of international institutions and the Congressional Budget Office in the United States” in giving consideration to dynamic impacts. However it argues that the current model offers an underestimate:

There are two limitations to the model, which are acknowledged in the report and suggest it could still understate the benefits of Corporation Tax cuts:

  • It does not capture the effect of lower Corporation Tax in encouraging investments that embody new innovations in the capital stock, or any resulting technological spillovers. That means it does not capture the potential impact of Corporation Tax cuts on long run GDP growth, and only assesses the impact on the equilibrium level of GDP.
  • The model itself does not capture the effect of lower Corporation Tax in encouraging foreign direct investment. Earlier research for the TaxPayers’ Alliance found that the effect on footloose investment was likely to be one of the most significant results of changes Corporation Tax rates. An ad hoc adjustment is applied to account for this but it would clearly be better if the CGE included at least a simple model of the international economy.

Therefore it should be seen as the “start of a process of developing and refining dynamic analysis to support and over time replace static policy analysis.”

Indeed The Treasury’s report itself concedes:

Although not captured by the CGE model, lower Corporation Tax rates could also boost productivity growth and therefore GDP growth…Productivity growth occurs when an improvement in education or technology in one period drives a further increase in the next period, for example high tech firms spark innovation which improves efficiency further. This affects the growth rate of GDP as firms are able to produce a higher value of output for the same input from one period to the next. A decrease in Corporation Tax rates may affect productivity by incentivising research and development (R&D) and high tech foreign investment, increasing labour productivity and wages.

Furthermore the TaxPayers Alliance concludes there can be no logic in only applying this to Corporation Tax:

“Dynamic analysis using the HMRC CGE model should be required for all fiscal policy changes announced by the Government. It should also be used to generate the key analysis in the Budget and Autumn Statement documents, such as the graph of the distributional impacts of policy changes. The report released with the Autumn Statement should not be allowed to become an isolated report with systematic dynamic analysis reserved for a flagship economic policy.”

This rather cautious model estimates that for every £10 of Corporation Tax revenue lost to The Treasury £6 is recouped in extra revenue due to growth.

Prudence is a fine principle. But there is nothing prudent about failing to allow transparency as to the real implications of tax changes. That would certainly be nothing prudent about a tax increase that reduced tax revenue.

One of the great implications about releasing information is that it then becomes harder for Governments to restore a regime of secrecy. These disclosures may be a modest start but they help future Chancellors have some regard to implications in the real world when setting out their demands for our money.

 

10 comments for: Dynamic Modelling: Corporation Tax must be just the start

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