David Green is CEO of Civitas.
With a Budget due on 3 March, the Government has been floating the idea of a windfall tax on ‘excess profits’ made during the Covid crisis. But instead of pondering how to punish companies that adapted successfully to the lockdown, it would be better to ask how we can most effectively accelerate our economic recovery
The case for some resolute tax cutting in the Budget is overwhelming. Excessive taxation can dampen the resolve of the most determined entrepreneurs. Top of the list should be a cut in corporation tax to ten per cent. At 19 per cent the rate is still high compared with several OECD members, and within the EU several countries charge much less. In Hungary it’s only nine per cent, in Bulgaria ten per cent and Ireland’s main rate is 12.5 per cent.
The low rate in Ireland has attracted a long list of international companies with at least a major office in Ireland, and often their European headquarters. Facebook has its European head office in Ireland, as does PayPal, while Google has a major presence. Airbnb has 500 employees, eBay has 900, and Microsoft 2,000. Other big names include LinkedIn, Accenture, HP, Apple, IBM, Pfizer and Pepsi.
It’s true that tax-avoidance shenanigans were heavily implicated in the location decisions of some of these companies, but the low headline rate was the clincher.
What would a cut mean for the public finances? In 1919-20 UK revenue from corporation tax was £63.2bn. If the rate were cut from 19 per cent to tern per cent this figure would be significantly lower, perhaps around £30bn.
However, we can predict a large increase in jobs, which in turn would increase revenue from income tax and national insurance. Both are far more important than corporation tax. In 1919-20 total HMRC revenue was £633.4bn, with income tax producing £193.2bn and national insurance £142.8bn. Revenue from both can be expected to go up sharply. Increased economic activity resulting from the cut in corporation tax would also raise the take from VAT, which brought in £129.9bn in 2019-20. If the revenue from these three taxes increased by only seven per cent it would more than make up for lower receipts from corporation tax.
Cutting the headline rate of corporation tax would also reduce tax avoidance and encourage companies operating primarily in the UK. It is notoriously easy for international companies to shift profits to overseas subsidiaries and pile costs onto their UK branches to reduce taxable profits. It’s much harder for companies whose operations are mainly in the UK to hide their profits, and a cut in the headline rate of corporation tax would be a just reward for their patriotism.
For many years the OECD has tried to reduce the scale of avoidance through its Base Erosion and Profit Shifting (BEPS) project. Member countries invariably give it lip service but little has been achieved. There is a huge literature about the devices deployed to avoid tax via controlled foreign subsidiaries, including strategies based on transfer pricing, the allocation of interest payments, and charges for intellectual property.
The lower the tax on profits, the less it’s worth spending on an army of accountants and lawyers to shift profits without breaking the law. And if international companies engage in fewer tax dodges, the Treasury can spend less on prevention. HMRC now has over 67,000 staff. Some could be transferred to more productive activities.
To make it clear that the aim is to incentivise job creation, the Government could also abolish capital allowances. At present when a company builds a factory or adds a production line it can’t treat the outlay as a cost that can automatically be deducted from taxable profits. Expenditure has to go into a special pool and is deducted from profits over time. It has long been recognised as a perverse incentive against investment, and in 2019 and 2020 the Government increased the capital expenditure that is deductible from £200,000 to £1m. Some want to increase this ‘annual investment allowance’ still further and to add to the list of items covered by the ‘first year allowance’, which is over and above the annual allowance.
But it would be lot simpler just to scrap the whole system and allow all investment in new productive assets to be a deductible cost. Such a dramatic step could easily lead to the multiplication of Nissan-style factories and well-paid jobs throughout the left-behind regions.
Cutting corporation tax would upset the European Commission, which may renew its protests against the evolution of the UK into Singapore-on-Thames. But having learnt nothing from the row over vaccine distribution, it will find itself vainly huffing and puffing again.
The Government is determined to spread prosperity to every corner of the land, but it should not be content with measures like posting civil servants to the North and redistributing infrastructure spending outside the South East. Improving roads, rail, ports and the internet is an essential component of a strategy of economic rejuvenation, but it’s no substitute for cutting corporation tax. Combining the two could be transformative.