The unintended consequences of raising corporation tax

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May 15, 2017 by Paul Goldsmith

Recent research found that in 1979, when Margaret Thatcher took over the country and the economic model changed, the workforce took 60% of GDP and owners of capital (shareholders and entrepreneurs) took 40%. Today, the figures are reversed, with the workforce taking 40% of GDP and owners of capital keeping 60%. When you consider those figures, you can see why Jeremy Corbyn’s plan to raise corporation tax (tax on profits) from the current 19% to a future 26% makes sense to a lot of people. Trying to fund the investments he wants to make and the rise in spending he plans cannot rely on taxing incomes that are falling, so trying to get more money from businesses might be an answer.

Yet I hark back to 1979 for a reason, and it isn’t just because I want to play the ‘back to the 70s’ card that people who fear a real discussion of Corbyn’s policies. Firstly, the businesses that pay corporation tax are far more footloose location-wise than in 1979, so can simply move headquarters to avoid paying it. Secondly, their money is similarly footloose. So Labour’s prediction of £20 billion a year income from this rise has been challenged by the independent Institute of Fiscal Studies, who suggest it will be more like £7 or £8 billion.

But that isn’t the most significant reason why relying on Corporation Tax may not work out quite as Corbyn predicts. A significant change that has also taken place since 1979 is who owns businesses. In 1979, only 7% of the country were shareholders of companies. By 1990 it was 25% as Privatisation changed the ownership structure of  British business, creating a new legion of small private shareholders. At the same time, pension funds grew more powerful and own more of British firms than they used to do in 1979, and they represent many current and future pensioners. 

So, if corporation tax rises, the money has to come from somewhere. It either comes from reducing dividends (a share in the profits) or it comes from reducing investment or it comes from reducing wage bills. 

Reducing dividends isn’t just taking money away from a Philip Green (or his wife) or a rapacious capitalist, it takes money from pension funds, which can reduce the money people get from their pensions and ordinary shareholders who use the money they get as important income to help get by. 

Reducing investment means reducing business growth, and employment, in the future. It means reducing investment into research and development of new products and services, building new factories, hiring more people too. Raising corporation tax might reduce this, particularly if other countries keep theirs low.

So, if investment is maintained, as are dividends, and the firm doesn’t leave the country, or divert profits elsewhere, what’s left to be used to pay the rise in corporation tax? Well, a company can lower their wage bill, by reducing bonuses, by reducing wage rises, or by making some redundancies. 

My point is not to say that the rise in corporation tax is ‘wrong’ and shouldn’t be done. Norway and Sweden have higher corporation tax rates but have plenty of investment and GDP. My point is to say beware of unforeseen, or in the case of the current Labour Leader, un-understood consequences. 

I welcome any comments - whether you agree with me or not!

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