The tax cut that would do most good

Tory leadership candidates are promising tax cuts. Matthew Lynn explains which one the winner should prioritise.

With the unfortunate exception of Rishi Sunak, who is boxed in by his record as chancellor, every candidate to take over from Boris Johnson as prime minister is promising spectacular cuts in tax. It is a little hard to work out what they have all been doing for the last couple of years while taxes were being raised to peacetime records, given how much they dislike them. But still, cynicism aside, it is refreshing to see that the Conservative Party still has some interest in lower taxes.

The trouble is, with an economy heading into recession and with huge demand for better public services, it does not sound very credible. We can’t cut national insurance, corporation tax, VAT, fuel duty or inheritance tax at the same time as spending record amounts of money.

With a recession looming, tax revenues will soon be going down and welfare spending up, putting even more pressure on the public finances. A winning candidate should choose one tax cut – and mean it. Halting the planned rise in corporation tax to 25% scheduled for next year is the best bet, for three reasons.

Hobbled competitiveness

First, it makes the UK uncompetitive globally. Corporation taxes have been steadily coming down around the world for the last decade, and the UK was quite rightly in the vanguard of that. In 1980, the average corporate tax rate was around  40%, according to figures from the Tax Foundation. By this year, it had fallen to 23%, and it is still coming down.

In the US, Donald Trump slashed corporate rates, and his successor has only partially reversed that. Sweden, Belgium and even France have all made significant cuts to their rates over the last few years. Over the last decade, the UK cut the rate by ten percentage points, and was set to bring it down even further, giving it one of the most competitive systems among the major developed countries.

Having left the EU and the single market, it was important to keep driving that down. After all, we need to make ourselves more attractive to global business, not less so. This is the worst possible moment to raise the tax rate businesses have to pay – and we will quickly pay a price for that as fewer companies decide to base themselves here.

Next, it will reduce investment. Firms don’t have many options when it comes to finding the money to pay for new product launches, extra manufacturing capacity, or setting up whole new units. They can try borrowing from the bank, although the answer is usually no, or they can raise capital from outside investors, although that is a lot of work. Usually they invest through retained earnings. If those are taxed more heavily, there will be less investment. Sunak did include a tax break for investment, but allowances are fiddly and hard to claim. They rarely work as well as the chancellor expects. The net result? Investment will be much lower than it otherwise would be – especially among small businesses.

The worst mistake

Finally, the Treasury gets the money anyway. Although it might come as a surprise to the people who constantly clamour for higher corporate taxes as if it were free money, companies don’t actually hold onto any cash. It all gets used one way or another, either to pay higher dividends to the shareholders or else higher wages to the directors or staff (and even if it is deposited in the bank, it will be lent out to someone else). When it is paid out, it will be taxed, and usually at a higher rate as well. One way or another the money finds its way into the economy and gets taxed. It just depends at what point, and at what rate.

The Johnson-Sunak government made lots of mistakes on tax policy. It was too quick to put taxes up, it didn’t put any serious thought into what to do with the money and it showed no real interest in controlling public spending. But of all of them the rise in corporation tax was by far the worst. It was too sudden a jump, taking the tax rate up by a third in a single step, it hit the sector we most need to grow, and it made the UK less competitive against its key rivals. The Tory leadership candidates are all keen on tax cuts. Make it that one.

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