Chancellor’s corporate tax raid is self-defeating and unnecesessary

Instead of gouging the wealth creators the Government should be trying to attract investors

‘Business investment has lagged badly. We are living off the fruit of past investment’

It is painful to watch an avoidable trainwreck unfolding before your eyes. Unless the Government changes course next week, Britain will tumble down the global league for business taxes, becoming one of the worst places to invest in the OECD bloc for the first time since the 1970s.

This will happen in recessionary conditions as the delayed effects of monetary tightening start to bite on both sides of the Atlantic. The policy is being driven by an austerity ideology that is hard-wired into Britain’s institutional structure, a culture with a bad habit of plundering business for quick cash to meet arbitrary and destructive fiscal targets.

It misreads the causes of last year’s gilts debacle. It implies that Britain faces a public debt crisis, which is not remotely the case. This country has a lower debt ratio than most G7 states. Inflation has already whittled away the Covid debt burden.

The National Institute for Social and Economic Research estimates that the Government will be running a budget surplus in real terms over the coming fiscal year. The debt ratio will be falling. It says Chancellor Jeremy Hunt has ample scope to limit the rise in corporate tax, and should do so.

The default setting heading into this Budget is that corporation tax will rise overnight from 19pc to 25pc while compensating allowances for investment on plant and machinery will be stripped away at the same time. The temporary super-deduction is deemed “eye-wateringly expensive”.

This double hit will raise the effective marginal tax rate (EMTR) for companies from 0.4pc to 9.8pc, according to Oxford’s Centre for Business Taxation. It is a violent tightening of the corporate tax system. Astrazeneca’s flight to Ireland for better tax treatment is the consequence.

The comparable rate in America is zero. Add $370bn (£310bn) of green tax credits and subsidies from Joe Biden’s Inflation Reduction Act and another $53bn from his Chips Act, and switching hi-tech investment to the United States becomes irresistible.

Prof Michael Devereux, an Oxfordbased world expert on business taxation, warns that investment in the UK could collapse by 20pc this year. “It could be even worse because a lot of companies will have brought forward investment in anticipation,” he said.

It would be a major surprise if Hunt steps back from this fatal misadventure next week. The steer from the Treasury is that some tax allowances will stay to mitigate the pain, but CBI pleas for “full expensing” have been ruled out as too costly.

Let us separate noise from the genuine problems that have emerged since Brexit. The media portrayal of Britain’s economic malaise is mostly misframed, exaggerated, and frequently crosses into caricature. You would not know that accumulated growth in the UK since the Referendum has been roughly the same as in Germany.

A macroeconomic historian looking back at Europe’s GDP figures for a century or more would see wars, oil shocks, recessions, and the pandemic, all leaping out of the chart. They would struggle to discern any effect from Brexit in the larger picture.

What is true is that business investment has lagged badly, even if revised figures are not as disastrous as originally thought. We are living off the fruit of past investment.

That disguises the underlying erosion of the productive economy, and bodes ill for the next decade. It is here that Brexit is hurting.

Rishi Sunak explored the British pathology of low investment in his Mais lecture as chancellor. “Despite the UK’S highly competitive headline corporation tax rates, the overall tax treatment provided for capital investment is much less generous than the OECD average”, he says. This is true.

“It is unclear that cutting the headline corporation tax rate did lead to a step change in business investment,” he said. This is to play fast and loose with countless variables.

In one sense what he says is an arithmetical truism. France raises half as much revenue from corporate taxes as a share of GDP despite higher headline rates – i.e. French companies plough the money back into investment rather than pay the tax. But France has a dismal record of attracting foreign inward investment (FDI).

This is where Sunak goes badly wrong. The UK would be in even worse trouble if it drove away FDI. Devereux says the critical point is to distinguish between the EMTR and the EATR (effective average tax rate).

The EATR has a powerful effect on where global multinationals locate new investment. That measure is highly sensitive to headline corporate rates. The planned rise to 25pc more than doubles the EATR from 4.2pc to 9.5pc at a stroke. That pushes Britain above France (9.3pc). Liz Truss was right to see the danger of this.

The EMTR is different. It chiefly influences how companies invest when they are already in a country. It is more sensitive to the business allowances. “Both matter,” says Devereux.

The conclusion is obvious for a country with a chronic investment deficit and a chronic trade deficit, living beyond its means and reliant on capital inflows to fund consumption: we should cut both the EMTR and the EATR; cut the headline tax rate; allow full expensing (minus debt); make it permanent. Stop monkeying with windfall taxes.

What we have now is profound confusion in Government taxation strategy: is it trying to lure investment, or is it trying to raise instant money by gouging wealth creators – despite the known economic damage and the diminishing fiscal return over time?

On a note of optimism, Devereux and colleagues have written the definitive book telling us how to fix a large part of the problem. We stop taxing multinationals where they produce. We tax the product where it is consumed. If Tesla wants to build electric vehicle batteries in Sunderland for export, the tax rate would be zero. If it located the plant in Düsseldorf or Zaragoza, the batteries sold in Britain would be taxed in the UK (via a modified form of VAT).

That would be an electric shock for our dinosaur tax regime. It would radically shift the British economy from over-consumption towards export-led growth, and vice versa for mercantilist Germany.

Europe would scream if the UK acted unilaterally, but leading EU states have already agreed in principle to such a change, known as “pillar I” in OECD talks, even if it has gone nowhere in practice. Britain could legitimately assert that it was leading the way towards a necessary reform of the international tax system.

The first-mover advantage would be massive. It would transform how global capital viewed the Brexit experiment. Call it Singapore or Seoul on the Thames if you want. It is a fair bet that any “cost” to the Treasury over 10 years would be trumped by the rise in the trend growth of GDP.

It is not going to happen next week. This caretaker Government is fixed on the immediate task of restoring Britain’s fiscal reputation. It lacks the mental bandwidth for revolutions.

One thing is certain: we will not break out of the bad equilibrium bedevilling the British economy by crushing investors.