PHILIP HAMMOND, the chancellor,
made a few tweaks in his Autumn Statement on November 23rd but otherwise stuck
to the fiscal policy set by his predecessor, George Osborne. A central plank of
this stance is to keep cutting corporation tax, which is levied on company
profits. The government hopes that will persuade businesses to invest in
Britain. It might, but on political grounds it still looks unwise.
As firms have become more
mobile, governments have had to work harder to keep them. The corporate-tax
rate has tumbled across the G20 group of rich countries in recent years.
Britain has led the way. Its rate was 52% in the 1970s. Between 2010 and 2015
it fell from 28% to 20%. Mr Hammond will bring it down to 17% by 2020. Theresa
May, the prime minister, has reportedly told her EU counterparts that, unless
she gets a good Brexit deal, she may slash the rate to 10%.
On one level, this looks
sensible. Well before Brexit, companies were complaining about a slew of extra
charges from the government. A levy to finance apprenticeships comes into force
in April 2017; it will cost firms about £3bn ($3.7bn) a year. A higher minimum
wage for the over-25s is now in force, ultimately raising wage bills by £4bn.
Brexit itself has created the biggest headache. By following through with cuts
in corporate tax, Mr Hammond hopes that he is “sending the message that Britain
is open for business”.
That message will be heard by
only a small number of firms, however. Fiat, an Italian carmaker (whose
chairman is also a director of The Economist’s parent company), moved its tax
residency in 2014. But only the biggest firms are likely to move to Britain in
response to lower corporation tax. Within Britain itself, the tax burden falls
disproportionately on a few heavy payers. All limited companies are liable, but
a recent Oxford University research paper found that just 1% of British firms
pay four-fifths of the total corporation tax bill.
For these firms, lower taxes
will boost the expected future return on capital, thus encouraging investment.
A paper from HMRC, the tax-collecting agency, looked at corporate-tax changes
between 2010 and 2016 and suggested investment would be roughly £4bn-6bn a year
higher as a result.
But at what fiscal cost? Those
changes also deprived the government of about £8bn a year in revenues. The
planned cut to 17% will ultimately cost another £3bn or so a year. The HMRC
paper counters that higher investment leads to faster growth, and thus a higher
tax take, so that within 20 years half the lost receipts could be recouped. But
a paper from the Institute for Fiscal Studies, a think-tank, criticises the
methodology behind this conclusion. Among many worries, its simplest was that
the estimates were subject to “a high degree of uncertainty”.
Uncertainty is especially high
right now. British companies seem not to be in the mood to invest. The
profitability of private-sector firms is at its highest level since 1998, yet
capital spending is stagnant. A marginal decline in corporate tax pales in
comparison with firms’ worries over workers’ measly productivity growth,
Britain’s future relations with the EU or Mrs May’s refusal to guarantee the
rights of the 3.5m EU citizens currently living in Britain.
A particular problem for Mr
Hammond is that, even if the tax cuts do not blow a hole in the public finances
in the long run, in the short term his fiscal needs are pressing. The budget
deficit is 4% of GDP and he has set three fiscal rules, including a pledge that
public-sector debt must be falling as a percentage of GDP by 2020. To this end,
he has also retained other parts of Mr Osborne’s legacy, including a cut of
more than £10bn from the working-age welfare bill by 2020, a move that most
analysts see as highly regressive.
What’s more, for Mrs May to
threaten the EU with a race to the bottom in corporate tax is hardly conducive
to harmonious Brexit negotiations. Even businesses recognise that, politically,
there is something iffy about the government’s approach. A big majority
surveyed by PwC, an accounting firm, believe that the tax rate should either
stay at 20% or not go below the 17% fixed for 2020. In purely economic terms
cutting corporate tax may do some good, but for post-Brexit Britain it is at
best a distraction.
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