David Gauke: My Budget advice to the Chancellor. Raise income tax, not corporation tax.

David Gauke is a former Justice Secretary, and was an independent candidate in South-West Hertfordshire at the recent general election.

If there is one tax that the Chancellor is likely to increase when he stands up to deliver his Budget on Wednesday, it is corporation tax. Speculation that the corporation tax rate is going to rise has been running for months and if the Treasury wanted to dispel such speculation it could have done so. In contrast to George Osborne’s time as Chancellor – when reductions from 28 per cent to 17 per cent were announced – Rishi Sunak is expected to announce a Corporation Tax rate in the region of 23 to 25 per cent.

Is this a good idea? My view – as the Minister of Tax throughout the Osborne Chancellorship – is that it is not. But it is worth examining the arguments for and against such an approach.

The first argument that will be made is that we might not need tax rises at all. I wish that this was true but sadly this is unrealistic. It is true to say that we can live with higher levels of debt than was the case in the past. Interest rates are low and likely to remain so. Even if they increase, the long dated maturity of our debt gives us a chance to respond. The markets are happy to lend to us, the risk of a sovereign debt crisis is remote. The Covid crisis is the type of event in which governments should be willing to borrow and the consequences can and should be dealt with over a long period of time. In short, we needn’t be in a hurry to pay off the Covid-19 debt.

Even accepting all of this – that ‘this time is different’ – there is still an issue. Even after we are put the economic consequences of Covid-19 behind us, the OBR forecasts a deficit of £100 billion or 4 per cent of GDP. Our debt to GDP ratio would continue growing. Given these forecasts assume tight control over public spending that will be hard to deliver and the significant demographic challenges that face the country in the 2030s, some kind of fiscal tightening in the form of tax rises will be necessary eventually.

The second argument is that now is not the time. I would agree that now is not the time for a fiscal tightening. The economy is currently shrinking and unemployment is likely to increase substantially in the months ahead. The markets are not jittery so there is less of a pressing need to take action. Nonetheless, the Government could increase some taxes without engaging in a fiscal tightening if long term tax increases are accompanied by short term tax cuts or spending rises. So one can announce and even implement tax rises without engaging in an immediate fiscal tightening.

There is also a political issue. Delaying action on fiscal consolidation might make economic sense but it would push tax increases into the last years of a Parliament. Leave it a year or so and the Chancellor might find that his Parliamentary colleagues – not least the Right Honourable Member for the marginal seat of Uxbridge and South Ruislip – might become rather resistant. Now might be the last chance to take action.

The third unconvincing argument is that cutting corporation tax has not cost us any money and increasing it will not raise you any money. Look at how corporation tax revenues have increased since 2010, the argument goes. Sadly, life is more complicated than that. Yes, rates have fallen and revenue has increased but corporation tax receipts reflects where we are on the economic cycle (in 2010, businesses were not making much by way of profits and if they were they had big losses to offset). Furthermore, the post-2010 reforms were Lawsonian in their approach in broadening the base at the same time as lowering the rate (so these were not simply cuts). In addition, lower corporation tax rates have unintended behavioural changes in that more people pay themselves through companies (diverting tax revenues from income tax and national insurance contributions). To put it another way, increasing corporation tax rates really will bring in more revenue.

So, to summarise, it will be necessary to increase tax revenue, it is reasonable to make a careful start on that process now (albeit in a way that does not tighten fiscal policy in the short term) and that increasing the corporation tax rate will bring in additional revenue. I could also add that, of all the potential revenue-raisers, this is likely to be politically less painful than other options. Even businesses will not squeal much because, for many of them, making a profit appears to be a remote eventuality and paying more tax on those profits would be a relatively nice problem to have.

It would still be a bad idea.

Why? If we are going to raise more in taxes – and we are already at historically high levels – we need to have a debate about which taxes are least damaging to economic growth. Over the long term, corporation tax ranks as being one of the worst.

Corporation tax is a tax on profits. Profits are the return on investment; the higher the tax on profits, the lower the rate of return. All other things being equal, the lower the rate of return on investment, the less investment you get.

There is also a tendency to think that corporation tax is something that is paid by, well, corporations. At one level that is true but – to state the bleeding obvious – all taxes are paid by people in the end. Corporation tax is ultimately paid by shareholders in lower dividends, consumers in higher prices and employees in lower wages. There is plenty of evidence to suggest that in an open economy like the UK, it is the workers who lose out the most. Investment goes elsewhere, productivity does not increase as quickly as it would otherwise do and, in the end, wages and salaries reflect productivity.

It is no coincidence that, in the era of globalisation, corporation tax rates have fallen around the world. I spent much of my time as a Treasury minister trying to persuade international businesses to locate more investment and activity in the UK as a consequence of the competitiveness of our corporate tax system. We were starting to see success but there was always a question as to whether the UK was truly committed to corporation tax competitiveness in the way that, say, the Republic of Ireland was. Given the current speculation, it was a fair question. On top of Brexit, a sharp hike in corporation tax rates will be yet another blow to our international reputation as a place in which to do business.

If we need more tax revenue – and we do – we have to make use of our big, broad-based revenue raisers – income tax, national insurance contributions and VAT. The manifesto pledge made in 2019 not to increase the rates of these taxes was unwise at the time but it was made in good faith. However, much has happened since and the Government would be justified in recognising that. Attempting to fill the fiscal black hole by swingeing increases in corporation tax will reduce business investment and damage our international competitiveness. Not for the first time, the politically expedient choice will come with a painful economic cost.

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Author: David Gauke


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