The link between corporate taxes and growth
Here in the UK, we are awaiting the revised budget by our current Chancellor Jeremy Hunt on 31 October. Part of this budget will be an increase in corporate income taxes from 19% to 25%. Liz Truss, in her immense wisdom, tried to convince the public that cutting taxes would spur growth and pay for the lost tax revenue by itself. This idea was driven by the free market think tanks in Tufton Street like the Institute for Economic Affairs. Now that corporate tax rates are expected to increase again, they claim that will reduce growth.
First of all, why anybody should listen to them after they nearly destroyed the British economy is a mystery to me. So, let’s talk about the link between corporate taxes and economic growth a little bit. As it so happened, last month Sebastian Gechert and Philipp Heimberger published a meta-review of the literature on the link between corporate taxes and economic growth. Looking at 441 estimates from 42 studies, the initial observation is that there is a wide range of outcomes, with some studies showing a positive effect of tax cuts on economic growth and other studies showing no effect or even a negative effect.
But here is the difference of modern economic research to economic research in the 1980s or 1990s. In the past, we would have just looked at the different studies and weighed the individual evidence. We would have found some studies more convincing than others. And some people like Patrick Minford would have simply dismissed all the studies that reject his preconceived notions of what the result should be. In the end, we would have drawn conclusions about the link being possibly positive, but not very strong.
Today, we know that there is a publication bias in the literature. That means that a study that finds a positive link between lower corporate taxes and economic growth is much more likely to be published than a study that finds no link. Gechert and Heimberger are able to put this effect in numbers and find that studies that find a positive link between lower corporate taxes and economic growth are 2.7 to 3 times more likely to be published than studies that show a negative result. After correcting for this bias, they find that “corporate tax changes have, on average, no economically relevant or statistically significant effect on economic growth”.
Please everyone, get that into your head: There is no link between corporate tax rates and economic growth and thus, hiking corporate tax rates simply isn’t going to be a burden on future growth while tax cuts are not going to spur growth.
In recent weeks, I have also been asked a lot by investors if the increase in corporate tax rates might make the UK less competitive in an international context and incentivise businesses to move to Ireland and other low tax countries. All the evidence we have is that in our modern world where corporate tax rates are very low almost everywhere this is not the case. Lowering tax rates to attract foreign businesses has worked for Ireland, Singapore and Switzerland in the past, when corporate tax rates in the UK, France and Germany were 40% to 60%. Today, the corporate tax rate in the UK is 19%, in the US 21%, and in France 32%. The tax benefits of moving from one country to another are so small that the costs of moving outweigh the benefits of a lower tax rate. Of course, if we were to raise corporate taxes in the UK to 40% or 50%, the story would be different, but the fact that we don’t hear any news reports about companies packing their suitcases in droves to leave France should tell you that even corporate tax rates around 30% are simply not an issue.