The fallacy at the core of Conservative economic thinking is that low tax works

Posted on

I have the following blog on the TUC's Touchstone site this morning:

At the heart of George Osborne’s economic policy is a deeply perverse belief that if he cuts public spending and services people’s confidence will increase because they will think that they will have more money to spend themselves as a result and so there will be economic expansion as they spend more in anticipation of this windfall.  This is called expansionary fiscal contraction. There is no evidence to support it: it’s very obviously not working. It has rightly attracted opprobrium,including from Paul Krugman.

This perverse, and failing, policy is matched by another perverse policy which will also fail, but which has not as yet had time to evidence that fact.  This is the policy of cutting corporation tax in the belief that this will increase both growth and employment, which is central to Osborne’s policy of cutting the mainstream corporation tax rate from 28%,  which it inherited from Labour, to 23% over a period of four years.

It is argued by many, including academics  and the OECD that there is, indeed, a relationship between growth, employment, and low corporation tax rates. However, new research that I’ve undertaken for the TUC, published today, leads me to seriously doubt this.

Using sample data  from OECD, EU  and other sources,  and considering a long time period, from 1997 to 2010   I found that whilst it is true that  there is some  limited correlation between falling tax rates and increased growth and employment, those links were so weak that other factors must explain the causation of the relationship, and that  changing corporation tax rates do not.

In fact,  applying  statistical analysis to the data,  and making sure that obviously dissimilar countries to the UK, like Ireland, Luxembourg, Italy and Japan in the case of growth (because the first two are both small states and tax havens,  and the last two  have suffered such low rates of growth that they cannot be compared to the UK) and Greece, Italy and Spain with regard to employment (because their employment patterns are so different from the UK’s), suggests that  just 7% of growth can be explained by the enormous range of different corporation tax rates offered by the countries surveyed, and only 6%  of the significant variation in employment rates can be explained by  differences in corporation tax rates.

That is significant: if comparison is made with countries like the UK, rather than making comparison to all countries, then it becomes very clear that changing corporation tax rates has almost no impact upon either growth or employment, and well over 90% of any difference has to be explained by other factors, which might well include the level of public spending in the country.

This research makes clear as a result that these cuts in corporation tax are likely to provide almost no return to UK economy, They are, on the other hand, guaranteed to make large UK companies richer. As a consequence, the gap between rich and poor in this country will increase whilst the resources available to the government will be reduced.

The research makes another very important point though, which is that is that the claim that these cuts in tax rates are necessary because the UK is uncompetitive is also wrong. The U.K.’s current corporation tax rates were already at or below international averages, and there is no reason to reduce them as a consequence. In addition, because well over 90% of all UK companies pay tax at the UK small companies rate, which is currently 20%, and this is vastly lower than the average corporation tax rate across most OECD and EU countries, we do in fact already have an extremely generous corporation tax regime in the UK, Despite that the obvious observation has to be made that it is not apparently delivering growth at this time. Why cuts should therefore suddenly deliver growth when low rates are not already doing so is hard to work out.

The reality is this policy of cutting corporation tax, just like the policy of expansionary fiscal contraction, appears to have no logic in fact: it appears to be entirely driven by dogma. That dogma is based upon a dislike of government and public services, and the desire to increase corporate profits at the expense of all other sections in society and parts of the economy. The resulting policy of tax cuts for companies, when almost everyone else is seeing tax increases, is further indication that we are not all in this together.

Indeed, the exact opposite is the truth: whilst my report shows that the government expects tax yields from income tax, national insurance  and VAT to increase significantly over the next few years corporation tax takes will, having taken inflation into account, flat line. There is, as a result, just one sector in the UK economy that is being favoured by the policy of cuts, and that is big business. Even small business will not benefit in the same way, its corporation tax cut is being cut by just 1%, whereas the cut for big businesses is 5%.

The implication is clear: this government is running an economic policy for the boardroom’s of big business, for bankers, international financiers, tax avoiders and those with significant wealth. Everyone else is having a tough time: for this elite though things have never been so good. And it is important to stress, there is no logic to this: this is political choice, designed to deliver gain for a tiny proportion of society at cost to everyone else.