Friday, February 3, 2012
High corporation tax rates penalise the only organisations capable of driving economic recovery in the UK, according to the Centre for Policy Studies (CPS).
According to a new report by the think tank, Chancellor George Osborne should slash the headline rate of corporate tax from its current level of 26% to 20% in his March Budget. The report's author, Research Fellow David Martin, argues that cutting the rate could do much to boost growth and international competitiveness. Martin also believes that Osborne could at the same time announce his intention to reduce it even further – to 15% or even 10%, once the appropriate anti-avoidance measures are in place.
In his report, Martin points out that the main rate of corporation tax has gradually been falling in the UK, from 52% in 1982 to 26% today, and shows that this rate cut has been accompanied by an increase in the revenue corporate tax generates for the Treasury. In 1982-83, it yielded revenues equivalent to 2.0% of GDP, whereas in this financial year, the Treasury expects a yield 2.8% of GDP (or GBP43.2bn). Martin concludes that dropping the rate still further would boost business confidence, encourage new investment by businesses (as it would improve net returns) and would send a strong signal that the coalition government is taking the supply-side measures necessary to restore growth.
It would also represent a major simplification of the tax system. Martin states that if the tax base was defined as business profits, then separate rules could be swept away, along with calculations for different sources of income. Complex rules for aggregating the results of these calculations, and for how profits and losses can be offset, could also be abolished.
In addition, lowering the rate could have a significant “wealth effect”. Martin notes that, as 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). The report argues that 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. As a result, private individuals will thereby achieve a higher valuation of their equity investments through rising share prices which potentially enhance consumer confidence, adding to the buoyancy of the economy.
Lastly, a 20% corporate tax rate could heighten the impact of any further Quantitative Easing (QE) – or possibly even reduce the need for more QE. Martin shows that the use of QE by both the Bank of England and the Federal Reserve has tended to result in higher equity prices, thereby enhancing consumer confidence through the “wealth effect”. According to the report, a reduction in corporate tax should achieve precisely the same effect. Moreover, it is felt that the effect could 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.
Commenting in Conservative Home on the proposals, CPS Director Tim Knox, wrote: "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."
"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%?", Knox concluded.